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ESOPs for Startups by Rodinhood

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Esops can change your life. They are probably the most valuable contribution that Startups make to the lives of employees who suffer low salaries and long hours while working in new Companies. …

Esops can change your life. They are probably the most valuable contribution that Startups make to the lives of employees who suffer low salaries and long hours while working in new Companies. However, ESOPs as a concept is confusing and complicated and needs to be understood well.

This is a humble attempt to demystify ESOPs.

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  • 1. ESOPs  for  Startups!   Guidelines  and  References     Alok  Rodinhood  Kejriwal   Oct  2012  
  • 2. Who  is  this  meant  for?   Entrepreneurs  who  need  guidance  on  ESOP  ideas   and  policy  for  their  Company.     Employees  who  need  to  understand  what  ESOPs  are,   and  how  they  work.     People  elsewhere  in  the  business  ecosystem,  who   may  have  questions  on  ESOPs  and  its  core  principles.     Anyone  interested  in  learning  about  a  very   interesting  and  valuable  capital  idea  that  has  been   responsible  for  creating  massive  wealth  for   employees  and  employers!  
  • 3. Disclosures:   The  principles  and  guidelines  spoken  about  in  this   presentation  are  used  and  adopted  strictly  for  the   2win  group  of  companies  that  I  operate/have   invested  in.     There  are  various  alternative  interpretations  of  ESOP   best  practices  that  other  companies  and  employers   may  adopt.     This  document  should  serve  as  a  guideline  and   reference  -­‐  not  as  a  rule  book!  
  • 4. Credentials  (proof  of  success)  
  • 5. Content  flow  1. What  are  ESOPs?  2. Why  are  ESOPs  important?  3. Who  gets  them?  4. On  what  basis  are  they  issued?  5. At  what  cost  are  ESOPs  issued?  6. When  and  how  are  they  given  out?  7. What  happens  if  you  leave  in  between?  8. Documentation/checklist    for  ESOPs  9.  10. Danger  Signs  
  • 6. What  are  ESOPs?   ESOP  means  Employee  Stock  Option  Plan.     the  Company  they  are  working  for.     the  plan  of  the  Company  issuing  the  ESOPs.  
  • 7. Why  are  ESOPs  important?   The  shares  of  Startups  and  unlisted  companies   become  quite  valuable  as  the  business  scales  rapidly   and  becomes  successful.     Unlike  salaries  which  cost  real  cash,  shares  have   them  to  work  for  the  Startup.     via  listing  and  acquisition  deals.  
  • 8. Who  gets  ESOPs?   a  company  is  entitled.     ESOPs         Even  founders  are  entitled  to  ESOPs  over  and  above   their  original  shares    it  can  be  an  additional   incentive  for  them  to  earn  more  shares  in  the   Business.  
  • 9. On  what  basis  are  ESOPs  given?   basis:   The  last  price  of  the  shares  of  the  Company,  as  invested  in  by  an   investor.   A  proportion  to  the  salary  of  the  employee.       We  sold  shares  in  the  last  round  at  Rs.  5000  per  share  to  an   investor.   You  work  at  a  salary  of  Rs.  7  lacs  per  annum.    -­‐  We  will  propose  allotting  you  150  shares,  valued  at  Rs.  7.5  lacs     (150  shares  x  Rs.  5000  per  share)  
  • 10. At  what  cost  are  ESOPs  allotted?   As  a  policy,  we  allot  shares  to  our  employees  at  a  base  price   Rs.  1/-­‐  per  share  (being  the  minimum  value  that  you  need   to  pay  for  buying  shares).     In  the  previous  example,  we  would  need  you  to  pay  the   Company  only  Rs.  150/-­‐  for  the  shares  that  are  actually   worth  Rs.  7.5  lacs     We  DO  NOT  believe  in  pricing  our  ESOPs  beyond  Rs.  1/-­‐   simply  because  our  business  is  not  listed.     What  VCs  pay  per  share  is  subjective  and  that  can  be  used    not  to  extract  a  cost  from  them.  
  • 11. When  are  ESOPs  allotted?   st  of   November  2012.     The  first  lot  of  ESOPs  will  be  available  to  you  AFTER  1   year  of  completed  service.  This  availability  is  termed  as           You  will  complete  your  cliff  in  October  2013.     We  grant  ESOPs  in  April  and  October  cycles,  so  you  will   be  entitled  to  your  ESOPs  beginning  October  2013.  
  • 12. How  are  ESOPs  allotted?   ESOPs  are  earned  in  equal  installments  over  a  period   of  employment  of  an  employee  (as  mentioned  in   the  vesting  schedule  given  to  you  by  the  Company   when  you  are  granted  ESOPs).     This       Our  policy  is  a  3  year  vesting,  earned  out  in  2  half   yearly  installments.     This  equals  to  shares  vesting  in  6  installments  over  3   years.  
  • 13. How  are  ESOPs  allotted?   In  your  case,  you  would  get  1/6th  =  25  shares  in   each  October  and  April  of  the  years  after  your  1       You  need  to  buy  your  vested  shares  from  the   Company  at  the  regular  vesting  schedule  by  paying   for  shares  at  the  value    fixed  by  the  Company  as   value  of  the  shares).     Once   to  you  by  the  Company  and  a  share  certificate  is   issued  to  you  for  the  allotted  shares.  
  • 14. What  happens  if  you  leave  the  Company  in  between?   If  you  leave  before  the  end  of  the  first  year  and  do  not  cross   the  cliff,  you  do  not  get  any  shares  in  the  Company.     Post  the  completion  of  the  first  year,  you  get  shares   depending  on  the  6  half  yearly  installments  that  you  have   crossed  and  earned.     cliff.  Then,  you  are  entitled  to  2  installments  of  1/6th  shares   each,  equaling  1/6th  +  1/6th  =  1/3rd  shares  when  you  leave   the  Company.  As  per  the  example,  this  would  mean  50   shares  are  vested.     When  you  leave  the  Company  you  need  to  claim  your   vested  shares.  
  • 15. What  happens  if  you  leave  the  Company  in  between?   To  claim  your  vested  shares,  you  need  to  pay  for  the  shares   following  which  the  shares  are  allotted,  printed  and  handed   over  to  you.     All    ESOPs  mention  a  deadline  period  for  you  to  pay  for  your   vested  shares  and  get  them  allotted.    In  our  case  we  have  a   30  day  period  post  last  date  of  employment,  by  when  you   need  to  pay  and  get  your  vested  shares.     If  your  finance  or  HR  is  kind  and  sincere,  they  SHOULD   remind  you  of  your  vested  ESOPs.     If  your  ESOPs  are  not  claimed  by  you  during  this  period,   they  legally  get  cancelled!  
  • 16. Checklist  for  ESOPs:         approved  by  the  SHAREHOLDERS  in  a  meeting  with  proper   resolutions.     A  sufficient  ESOP  pool  should  to  be  created  with  enough   shares  that  last  for  at  least  5  to  7  years  of  operations.     Typically,  the  ESOP  pool  should  be  approx.  10  %  to  15%  of  the   share  capital  of  the  Company.     The  grant  letter,  the  vesting  schedule  and  the  entire  plan   should  be  a  part  of  the  document  set  given  to  employee  when   granted  ESOPs.  
  • 17. General  Concepts  explained  Why  is  a  cliff  imposed?    There  are  2  reasons:    1. As  a  new  employee,  you  need  to  prove  your   commitment  and  value  to  the  Company  before  it   rewards  you  in  terms  of  precious  equity.    2. Remember  that  the  Company  was  valuable  before   you  joined,  and  so  you  need  to  add  value  to  it  to  be   able  to  participate  in  its  returns.  You  need  to  invest   your  time  and  efforts  in  the  Company  also.  
  • 18. General  Concepts  explained  What  can  be  your  real  gain?    1. 150/-­‐  and  buy  150  shares.    2. Rs.  5000  per  share.  After  4  years,  the  Company  gets  acquired   at  say  Rs.20,000  per  share.    3. Your  value  of  your  shares  will  be  Rs.  30  lacs!    4. In  your  case,  the  salaries  you  will  have  earned  in  the  4  years   would  be  approx.  Rs.  34  lacs  (Rs.  8.5  lacs  per  year  as  a   blended  average)  and  you  will  have  further  gained  Rs.  30  lacs   value  in  ESOPs!  
  • 19. Questions  &  Answers    A:  As  per  the  rules,  you  cannot  get  shares  without   paying  some  moneys  to  the  Company.    Q:  Can  I  get  more  shares  via  ESOPs  beyond  the  lot  that   was  promised  after  my  first  year?  A:  Yes  of  course!  The  idea  is  to  compensate  employee   performance  with  regular  issuance  of  new  ESOPs.   also  realize  that  your  first  lot  of  ESOP  shares  also   grows  each  year  in  value!  
  • 20. Questions  &  Answers  Q:  What  about  taxes?  Are  there  some  complications?  A:  When  ESOPs  are  vested  and  you  claim  the  ESOPs  for  allotment,  you  will   be   taxed   for   the   taxable   value   of   ESOPs   as   part   of   your   salary   perquisite.     e.g.  If  you  pay  Re.  1  (Face  Value)  per  share  and  value  per  share  as  per   valuation  report    or  last  transaction  is  Rs.  5000,  you  will  have  to  pay  tax   as   per   your   salary   slab   (1%,   20%)   on   the     perquisite   value   i.e.   on   Rs.   4999/-­‐  (Rs.  5000  LESS  Re.  1).     Now,   at   the   time   you   sell   your   shares   (for   Rs.   20,000   per   share),   you   will  have  to  pay  tax  on  the  gain  amount  (Rs.  20,000-­‐Rs.  5000  x  No.  of   shares)   as   capital   gains,   as   you   would   for   any   income   from   sale   of   shares.    Q:  Can  I  sell  my  shares  to  others?  A:  It  depends  on  the  popularity  of  the    shares  and  the  market.    possible  but  it  could  also  depend  on  Company  policy.  Closely  held   and  private  Companies  restrict  transfer  of  shares.    
  • 21. Questions  &  Answers  Q:   How   do   I   know   what   %   of   shares   I   have   in   the    Company?  A:   This   is   a   tricky   one.   Most   employees   will   not   know    and     not   important,   as   long   as   you   trust   the    management  to  be  fair  in  telling  you  what  the  value    of   shares   was   when   VCs   invested,   and   how   many    shares  you  are  getting.       Please   note   that   when   senior   &   director   level   appointments  are  made,  %  are  decided.    
  • 22. Watch  out  for:   The  management  keeps  postponing  and  formalizing  ESOPs.   Either  they  are  being  greedy  or  lazy  or  have  not  been  able       You  SHOULD  receive  printed  share  certificates  of  your   holdings  once  a  year.  We  do  it  as  a  rule.  INSIST  on  getting   your  shares  and  written  confirmation  of  holdings  before   you  leave.     understand.     Figure  out  whether  ESOPs  are  being  given  to  everyone  and    
  • 23. Thanks!     Special  thanks  to  2win  CFO  Satish  Iyer   (satish@c2wgroup.com)  for  helping  validate  this   document  and  administering  2win  ESOPs!  
  • 24. Connect  with  me  and  give  me  feedback!   e-­‐mail  -­‐  alok@rodinhood.com       Facebook  -­‐   facebook.com/rodinhood       Twitter  -­‐  @rodinhood         My  social  network  for  anyone   enterprising!   therodinhoods.com     Blogs  and  articles  written  by  me       Presentations     http://slideshare.net/rodinhood  

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