By giving away some equity, startups can build a strong team that really cares about the company doing well. For employees, ESOPs are a win-win—they get a financial reward and a real sense of ownership in what they’re working on.
Is ESOP right for my startup?
Before diving into ESOP, startups should pause and evaluate if it aligns with their growth and goals trajectory. Here’s a quick checklist:
- Growth expectations: Your company should aim for a YoY growth rate over 20 . With ESOP, you give your team an upside from your company’s growth. If growth is not really the name of the game for you, ESOP won’t make much sense.
- Profitability: ESOP is designed for companies that aren’t profitable yet. Once a company is profitable, it can simply distribute the profit to the team. ESOP works best for pre-profit companies because it promises huge upside if the company succeeds.
- Talent attraction & retention: ESOP makes sense if you want to attract new talent and keep your current employees. Which we assume you do.
- Ownership mindset: For a founder, ESOP basically means giving some of your equity away. This is a huge deal. That’s why it’s so important that founders believe to their cores that this is the right thing to do.
If you’ve checked all these boxes, you’re on the right track! Now, let’s dive into the next steps.
Choosing the right ESOP plan
Navigating the world of ESOP can feel overwhelming for founders. It might seem like your startup is unique and needs special treatment. But truth be told, most startups will choose one of the standard ESOP plans.
Now, the way countries all over the world treat ESOP varies a lot. That’s why we’re picking four ESOP types that are either pretty much universal, or that are available to companies headquartered in some of the biggest startup hubs in the world.
1. Phantom plan
A phantom plan, also known as a virtual ESOP, is a type of ESOP that gives employees a share in the company’s success without actual stock transfer. Instead, the employees get phantom shares which entitle them to a cash bonus payable typically on exit. The value of phantom shares mirrors the value of actual shares. When the company valuation increases, the value of phantom shares grows as well. Phantom plan is ideal for early-stage to growth-stage startups that are starting with their first ESOP and they want to get started fast. Read more here.
2. STAK
The STAK plan is a tax efficient type of ESOP commonly used by Dutch companies. STAK (Stichting administratiekantoor plan) is a trust set up by the company to allow employees to own the so-called depository receipts (DRs). Put simply, DR-holders have financial rights of a shareholder without the decision-making powers. The STAK plan is ideal for mid-sized to large Dutch startups, but also works for other European companies. Read more here.
3. EMI
The Enterprise Management Incentive (EMI) is a government-backed share option scheme. The EMI plan allows UK businesses to offer stock options to their team in a way that’s tax efficient for both the employees and the company. The goal of the plan is to help startups recruit and retain talent effectively. The EMI plan is perfect for small and medium UK-based companies with a substantial number of UK-based employees. Read more here.
4. US stock options
The US stock options plan is a tax-efficient share option scheme used primarily by companies headquartered in the US. This plan gives employees the right to buy company shares at a predetermined price (strike price) after a specified period. This kind of ESOP is designed for US-based companies with a substantial number of US-based employees. Read more here.
Getting the hang of these plans is step one. But it’s not rocket science. You need to pick a plan that aligns with your business goals now and in the future. If you want to get started fast, pick a phantom plan. If you want to move your headquarters to the US because of business or investors, pick a US stock options plan.
ESOP milestones
Once you pick your plan, you need to make some big moves. We’ve summarized the most important ones here for you:
- Create your ESOP pool and divide it to your team: First, you need to create your ESOP pool and decide how much you’ll allocate to your team. At seed, ESOPs are traditionally set at 10 % in both the US and Europe. US startups then typically increase their pool to 15 % at Series A up to 20-25 % at Series D. In Europe, the ESOP pool often stays at 10 % throughout the funding journey, but we see the trend changing here as well. Once you decide on your ESOP pool size, it’s time to allocate it. Make sure you take into consideration future hires as well as current employees.
- Design plan parameters: Every ESOP plan, no matter the type, has its rules. Here are the ones that will make or break your plan:
- ESOP eligibility: Decide who can participate in your ESOP and if there are any conditions to participation (e.g. minimum length of employment).
- Award type: Decide on the mechanism for granting equity to your team. Standalone awards come on top of salary and bonus. Swap awards let employees exchange part of their salary (typically a salary increase or a bonus) for equity.
- Vesting parameters: Lay out a timeline when an employee’s award becomes fully owned by the employee. The most common scenario is a 4-year vesting period with a 1-year cliff.
- Payout conditions: Define when employees can cash out the plan. Most plans allow payout on exit. But because exit can be a thing of the distant future, some companies let their people sell some equity to investors during investment rounds (secondary market) or buy back their equity whenever there’s enough liquidity.
- Good leaver & bad leaver scenarios: You need to decide what happens when somebody leaves your company. Good leavers (who leave on good terms) keep their vested assets and the company can buy them back. Bad leavers (who breach a crucial obligation to the company) typically lose all their ESOP rights.
- Create legal documents: Create all the necessary ESOP documents.You’ll most likely need:
- ESOP terms & conditions detailing all the ESOP rules and parameters,
- Award agreements for individual employees.
- ESOP eligibility: Decide who can participate in your ESOP and if there are any conditions to participation (e.g. minimum length of employment).
- Introduce ESOP to your team: Before launch, hold sessions with your employees to discuss why you’re implementing ESOP, how your ESOP works and what the benefits are for your people. Use simple language, provide real-world examples and answer questions to ensure everyone understands and feels excited about ESOP. And keep the communication going post-launch as well.
- Launch and manage the plan: With everything set, you can officially roll out your ESOP. To manage the plan, you’ll need to:
- give regular updates to employees on the status and value of their equity,
- track allocations, vesting and exercises,
- review and adjust the plan as needed to stay in line with company goals and market conditions.
- Real-life example of ESOP success
Our customer, a startup in the hospitality business, introduced ESOP after its seed round to boost recruitment and create an ownership mindset. ESOP was a key factor in scaling the company to 800+ employees and helped attract talent across 20 countries. To demonstrate the very real benefits of ESOP, the company also lets their employees sell equity to investors during investment rounds. Our customer’s CEO says this about these so-called secondary sales: “Thanks to the secondary market, a lot of people were able to pay off mortgages or buy a car. It just feels so good to show our employees that there’s a real value in this ESOP plan.”
- ESOP platform to the rescue
Jumping into the ESOP world doesn’t need to be scary. While many founders might think their needs are unique, they typically aren’t. Let the Eldison ESOP platform help you set up and operate one of the standard ESOP plans. Discover the magic at edison.com/platform.
Last but not least, feel free to contact me:
** Štefan Šurina – author of this blogpost, seasoned law & technology enthusiast and founder of Eldison, a company that combines legal & tech to help local and global innovators shoot for the stars. Besides helping startups and scaleups with anything legal, Eldison built an ESOP management platform designed for European founders.
** Lucie Ottinger – recovering lawyer, startup generalist and sucker for innovating legal industry through technology. Lucie’s managing lead generation & customer acquisition (Growth) at Eldison and she’s the go-to person to chat to about anything ESOP related.
