Building employee-friendly ESOP Policies | #LetsTalkESOP

“The biggest challenge for most startups is to keep the startup operational while managing employees’ salary expectations. A solution to this problem is ESOP grants,” says Anirudha Modak, Founder & Principal Consultant at Guru On Tap Consulting – a Pune-based boutique consulting firm. In his 30+ years of professional experience, Anirudha has worked across several roles, including sales, marketing, business development, and operations in India and abroad. He climbed up the ladder and became the Business and Operations Head – India of a listed IT company for around 3 years. 

In this episode of #LetsTalkESOP with trica equity, Anirudha talks about his journey and the creation of Guru on Tap Consulting. He sheds light on some of the biggest challenges that founders face while running startups and the role that ESOPs can play in streamlining the journey for founders. Anirudha also shared his take on how ESOP policies are different in startups and SMEs and what employees should do to evaluate their grants.  

Tell us the story behind the inception of Guru on Tap Consulting. What were your motivations? 

My entrepreneurial plunge started with a FinTech startup. I went on to exit from it in 2016 and was not even 50 at this point. 

When I was running my startup, a lot of people had advised and invested in me. Being a founder, I know how much I have gained from that. So, I always felt the need to do the same and help young founders in whatever measure I could. After finding an exit from my startup, I decided to partner with a friend and leverage my professional experience in the startup ecosystem to advise entrepreneurs. Eventually, I founded Guru on Tap Consulting. Guru on Tap is a boutique consulting firm where we work with startups and MSME & SME founders. In addition, we provide consultancy services on business strategy, sales, marketing, technology, and HR as an organization. 

What were some of the biggest challenges that you faced while building and running your company? And, in that context, what are some of the fundamental challenges that every founder goes through?

No matter how much skin you have in the game, the influx of working capital is innate to any startup. Building upon that, keeping the startup operational while being non-profitable is one of the biggest challenges that every founder goes through. Another challenge that early-stage founders face is hiring senior team members – with minimal capital in hand, it becomes challenging to offer market-average compensation to senior employees. 

To sum it up, the biggest challenge is to keep the startup operational while managing employees’ salary expectations. 

What role do you think ESOPs can play in a startup? In the last few years, what are some of the innovative frameworks you have seen coming up around ESOPs?

A lot is happening around ESOPs. One trend I am seeing is that founders are offering more ESOPs while hiring. They are leveraging the concept of wealth, rather than income, to drive thetrica equitylves and drive their teams. Earlier, it was about monthly compensation, but now founders are using ESOPs as an employee retention tool until vesting is completed.

One common framework these days is the issue of performance-based ESOP grants. If a particular employee performs better than expected or meets their pre-defined milestones, either ESOPs are granted or a certain number of grants vest. 

When it comes to the vesting period, there is no clear trend that I see rising. But I very clearly see that the incidence of ESOPs is growing quite significantly in startups and MSMEs & SMEs.  

You have seen SMEs that offer ESOPs. But, SMEs are typically promoter-held – they are different from startups where employees work very closely. What are some of the things you are now observing in the change of thinking around these promoters and why they are looking at ESOPs?

Today, SMEs are competing fiercely amongst thetrica equitylves and with startups and other big players. Hiring top talent becomes key to stay alive in the competition, but they generally are not equipped enough to match cash expectations. I advise about six SMEs, and in three of them, we have had discussions on giving ESOP grants while hiring. To onboard core team members such as a CEO or VP, ESOP is a powerful tool. 

By granting more ESOPs to employees, SME founders are developing a culture of ownership, leading them to share their opinions around challenges, strategies, and business plans more freely. 

Typically, early-stage startups have an ESOP pool of around 10 to 15%. What, according to you, is the average pool size in the SME space? Also, shed some light on the vesting pattern of ESOPs in SMEs.

I have seen that SMEs have a smaller ESOP pool size when compared to startups. Traditionally, in startups, the pool size is anywhere between 10 to 20%. In SMEs, however, the pool size is typically less than 10% – somewhere between 2 to 8%

Vesting periods in SMEs are slightly more extended than those in startups. This is because SMEs come from a more conservative or legacy-based thought process.

I have a few SMEs who use ESOPs as retention grants. For example, let’s say the SME has defined a vesting period of four years. At the end of the fourth year, the employee will get additional ESOPs that typically have another lock-in or a cliff. This way, SMEs retain talent for seven to eight years. 

What are your thoughts on the management of ESOPs? Typically, they tend to be managed on an Excel sheet by HRs or CFOs. How well do founders understand ESOPs as a concept, and what can be done to make the process of management of ESOPs seamless?

Many founders, be it startup founders or SME founders, don’t understand the topic as well as they should. Many of them traditionally look at ESOPs as just another recruiting or retaining tool and come from a mindset that they are doing a favor to somebody by offering ESOPs.

I feel experts should manage ESOPs. It will be helpful for a company to look at experts or create an internal board of trained people who understand ESOPs and their management. Also, founders should create the ESOP pool as early as possible. Finally, organizations should be transparent with their employees on ESOPs when it comes to valuations. This will lead to expectation and intention sharing. 

I would advise founders to go in for expert advice and customize a suitable ESOP policy by laying down their expectations.

What are some salient features of an ideal ESOP policy?

In my opinion, if a person has delivered results and has been loyal for a certain period, their exit should not bar them from exercising their ESOPs. Employers should respect team members to nurture a culture of goodwill and trust within the organization’s rank and file. 

Some salient features that I see are a large ESOP pool (10 to 15%), option multipliers based on roles, and periodic retention. In my opinion, the vesting period should not be too long as you want employees to make money from ESOPs, and that is too soon. From my point of view, the ideal vesting period for ESOPs is 2 or 3 years. I believe ESOPs should be seen by employees as wealth-generators and not just money on paper.

If I am an ESOP-privileged employee, what should I expect and ask my employer to understand my grants better? When should I liquidate my shares? 

When I was given ESOPs, the first thing that came to mind was confusion regarding exercise price, fair market value (FMV), and vesting period. First thing as an employee, I would expect my employer to be very transparent with me on the wealth creation prospects. 

Another thing I would like to know as an employee is how my employer has arrived at the valuation. When they offer ESOPs, they must have arrived at some valuation of the share price. If the share price goes up, the valuation goes up. A few companies have a good practice of creating a team of people who can influence the company’s overall performance in a better way. If people from different teams working together could drive better results, the share price will eventually increase. And employees will be motivated. 

I would expect advice from my company on the right time to liquidate or not. Many times there is always that there is a mixture of fear of missing out and fear of liquidating too early. Employees are not stock experts. So, the company should advise on when and how much to liquidate. Also, as an employee, I expect periodic updates on the company on my ESOPs and their performance. 

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As the founder of a startup and SME consulting firm, I see ESOPs are picking up steam in India. However, while companies leverage ESOPs to attract and retain top talent, there are many gaps to bridge when creating actual employee wealth. I would like to see founders pave more ways for employees to realize the true potential of ESOPs.