An Employee Stock Option Plan (ESOP) is a way to give equity (or ownership) in your company to an employee or contractor. A slice of the cake, if you will.
But how much of the cake should you share? No two companies are the same, so it is important to specifically consider your own staff, and your plans for the next few years. Above all, every company should keep team incentivization top-of-mind.
Size of the Pool
A good starting point when thinking about Option allocations, is to consider the total sizeof the Option Pool. For example, if the company has an allowance for a 10% Option Pool, and it wants to offer Options to at least 20 team members over the next couple of years, it clearly needs to take this into account in making the allocations.
Valuation of Options
It can be useful to work out the value of Options by considering how much they’d be worth if they were offered as stocks as part of the most recent Capital Raising round. This is especially useful where the Options are being offered as a remuneration package top-up, as the company can clearly communicate how they decided how many Options would be offered, based on the most recent valuation of the company.
Role v Time
While Option allocations will sometimes vary between roles, it’s more common for them to be based on time spent in the company. For example, the early employees will have higher allocations, and the later employee allocations will be smaller, despite them being in similar roles. Although this isn’t to say late joiners can’t get higher allocations – it all comes down to the specific values of the team member and company goals.
It’s quite rare for an employee or contractor to receive more than 1% fully diluted ownership in a company, except where that team member is a senior hire, or the Options are in substitution for a significant salary package.
Please keep in mind that where the recipient is an employee, they must be paid at least the minimum salary under the employment laws relevant to your jurisdiction and this salary cannot be substituted with Options in most jurisdictions.
How do you value your Company for an ESOP?
Often, a company will initially be valued internally to determine how much equity they want to give to each participant, and then the company will apply the ESOP specific valuation to set the Exercise Price in compliance with any tax rules.
The your jurisdiction may have specific valuation requirements for setting the Exercise Price for an ESOP. It is important that you ensure you use the correct method of valuation to access any available tax concessions.
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This blog is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.