Normally when risk-capital startup companies (startups) raise funding, investors require that some 10% – 15% of the company shares would be allocated to existing and future employees. This is done in a formal manner via ESOP – Employee stock ownership plan.
How is the Employee Stock Ownership Plan Utilized?
ESOP shares are distributed among the company employees in the form of startup stock options, or simply: options.
Let’s take for example an Israeli startup company, which plans to strengthen its US market presence. It then recruits a high-profile American employee, perhaps CEO or VP sales. It is likely that such an employee would be compensated with both salary and a substantial amount of options.
Such a significant amount of options, would make an employee a true part of the company. To better understanding options see Startup Stock Options… Are they Any Good? Or check “cold” definition of options.
How Many Options do Startups Employees Get?
A hired CEO may get as much as 5% of the company shares (in options). Early employees such as senior developers or VP product may get 1% of the company shares in options. In contrast, a lesser senior or a later employee may receive just a fraction of a percent (less than 0.1%) or even nil.
It has been more than once, that company’s founders were heavily diluted throughout the funding rounds, left with virtually nothing. If the founders still perform strategic duties for the company, then they may receive options just as well. Otherwise they may develop frustration or lose interest!
It seems that ESOP and startup stock options are merely the same thing, or isn’t it?
The Difference Between ESOP and Options
Indeed employee options and ESOP refer to the same concept or idea. However, the perspective is different: ESOP represents the relationship between the company and its management / investors; Whereas options represent the relationship between the company and its employees.
Let us clarify…
ESOP – the Risk Capital/Investor Relationship
ESOP is part of the strategic planning of a startup. ESOP is at many times the result of a requirement by potential investors. Investors usually require that 10-15% of the company shares would be allocated to employees, via ESOP. This is usually agreed upon in the investment agreement.
Early-stage startups are at many times low in funds. Thus salaries may be on the lower side. Rather than increasing salaries, investors may prefer to compensate employees with options.
Once ESOP is in place, the startup has flexibility as far as which employee gets which amount of options.
Usually ESOP is discussed among the company’s management, including its board of directors, CEO, CFO, Investors, CPA, investors, etc.
Employee Options – The Employee Perspective
Employees options are the by-product of the ESOP. Once the company has a plan in place, it can then distribute options to its employees.
Usually options are discussed with employees as part of the compensation negotiations.
Naturally, employees care more about the amount of options they personally receive, in contrast with how many shares the company may have allocated as a whole (ESOP).
The agreement between the company and employees, which formalizes distribution of the options is called “Options Entitlement” or “Options Certificate“.
ESOP and options are virtually the same thing. ESOP however, reflects the company’s perspective, e.g. how many shares are allocated as a whole. In contrast options the specific shares held by specific employees.