ESOPS and their Basis..

So, is there a science of paying out ESOP grants?

First the basics:

– Esops are ‘shares’ that are given to employees in new gen Companies.

– Esops have many flavors. The (only) type my group hands out is:

• The shares cost Rs 1. So the employee need not pay for the shares.
• The first year of employment is called a ‘cliff’. Meaning you have to work for 1 year to prove that you are loyal and hence deserve Esops.

• Once you are past the 1st year, you get ‘Esops’. So, let’s assume you get 90 Esops as your ‘grant’. These 90 shares will be entitled to be issued to 1/3rd per year going forward – so 30 shares this year, 30 shares the next, and 30 shares the final year.
• Now, if you leave the Company after the first year of getting the grant, then the 30 shares that you earned are yours. My Company prints the shares and gives you the certificate in exchange of you paying Rs 30.

• What happens if the Company gets SOLD while you are, say in the 1.5 year of service (after the 1st year cliff)? Well, YOU Get ALL the shares. That’s because you signed up to work for this Company and the current management – NOT for the New Company and its acquirer.
• Surely, the new Company WILL also give you Esops in this existing Company/Acquiring Company, ‘coz they wanna hold you back.

Now, this as far as the Concept and functioning of ESOPs.

My Open Question here is – WHAT SHOULD BE THE BASIS OF ESOPs?

– When really senior management comes on board, they usually negotiate a fixed % of the Company as the ESOP. 

That’s because, in their minds they project – lets assume the Company sells for 100mn US$ and they own 1%, then they will walk away with 1 million $$$.

Probably ‘WORTHWHILE’ for a 35 year old to quit a 9-5 job in Yahoo! and jump on ‘coz he just gets a kick out of earning 1 million US$ that he would not get anymore at Y!

– For the JUNIOR and MIDDLE MANAGEMENT, how does one structure the ESOP grants such that:

The grant given out is:

– VERY EASY to Communicate

– MAKES AN IMPACT – it’s almost saying “we will pay you ‘X’ – that ‘X’ being a tangible value

– AFFORDABLE to the company?!

As a simulation, 

Let’s assume that an Internet Company generates a topline of 10 million US$

Since, it’s an Internet Company, it will be probably valued at 50 – 70 million US$ ( 5x – 7x of topline)

Let’s also assume that its ESOP pool is 10 % (standard)

So, if the Company does get sold, then 5-7 million US$ will be distributed to employees.

Now, with a 10 million $ topline, its salaries are probably 3 million US$ a year.

Reduce salaries of top management etc (they are founders etc), and you are left with 2.50 million US$ a year.

Also assume that it takes 5 years of hard work for the Company to reach where it is.

Take out 1 year of the effort put in to remove the Cliff.

So, we are left with 4 years of Salaries * 2.5 million $ per year = 10 million dollars PAID OUT

The LEAST the ESOP payout should be also 10 million? (least)

So, the Company should have sold AT LEAST for 100 million $$$?

If so, then you can promise employees – By the time you leave the Company, you will earn what you earned in the job ALSO AS ESOPs!

If you look at the delicate balance of this equation:

The Sale Price of the Company as a function of the Employee salary is really the CRUX!

And that really NEEDS to be communicated every passing day to the employees. That their contribution in the Company can earn them their salaries ALL OVER AGAIN – if they build value!!

Undoutedly, when a Company becomes very valuable very fast (facebook, yahoo!, google, Infy), then its founding team members get VERY VERY RICH. But that’s a rare case.

This discussion is to probe – what happens to Companies that are moderately successful?

And WHAT should be the quantum of MONEY earned by employees when they SELL their shares.

Finally, this discussion is to DEBUNK the cheap sales tactics of some Companies who fool their employees by telling them “Wow, you are getting 10,000 shares” or “You know what, your shares are priced at 20% lower than the market price”… etc etc BS.

Oh, there are Companies that DON’T give Esops!! I wonder who works for them?

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