Basics of ESOPs Series 3

In Volume 2 of The basics of ESOPs, we understood how to frame an ESOP policy and how to create an ESOP pool. In this volume, we will talk about what’s the best time to create an ESOP pool and what happens when an employee leaves before the options are vested.

When is the best time for founders to create the ESOP pool?

Advice from various start-up founders in India: 

● As early as possible: “Create the ESOP pool as early as you can. I believe the ESOP pool and associated governance processes should start from Day 1.” - Satheesh KV, former HR Director at Flipkart & co-founder of Spot table

● “The ESOP pool should be made as early as possible. When the company approaches Series A, the ESOP pool size should be around 10% of equity on a fully diluted basis.” - TN Hari, Head HR of BigBasket 

● A 10% pool is minimally advised in the beginning: “A 10% pool is great to have in the beginning. Anything less is not that good. In later stages (say Series C or Series D), the pool might shrink down to 3 or 4% as the valuation of the company goes up” - Deepak Abbot (VP at Paytm, Founder of startup in stealth mode) 

Advice from EY Masterclass (a Singapore-based perspective):

● The best time to set up the LTIP is sometime between pre-seed and early VC. 

● In the Pre-seed stage, companies usually do not issue LTIPs as their focus is on traction but core team is given equity/options on ad-hoc basis. LTIPs are not necessary in pre-seed rounds but it can be helpful for to sense-check how much equity is given to the early hires. 

● In Seed, institutional investors typically require LTIP. Seed rounds can be closed without LTIP but the benefit to issuing an LTIP at this stage is that seed investors can share in the dilution. Upon first outside financing round, institutional investors or angels would require LTIP.

● By early VC, investors require LTIP in place to serve as a guideline for the size of new-hire option grants. New hires usually seek large equity grants. 

● By late VC, employees still want equity so it is important to standardise LTIP and the amount of equity granted. 

● By growth period, the company is likely to have exhausted most of its LTIP but the remaining shares are all the more valuable to allow new hires to share in the upside.

What happens if my employees leave before the options are vested?

It depends on the ESOP policy set.

The norm is for the unvested ESOPs to cancel upon cessation of employment. This means that the employee will not be able to exercise and avail ESOP benefits from those ESOPs any more.

However, in case an employee suffers a permanent incapacity while in employment, all the ESOPs granted to him as on the date of permanent incapacitation, shall vest in him on that day and in the event of the death of an employee while in employment, all the ESOPs granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

Watch this space for Volume 4 of the Basics of ESOPs series by Qapita where we will discuss the definition of key ESOP terms that you need to be aware of.

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