1: What is an Employee Stock Option Plan (ESOP)?

An ESOP is a structured compensation scheme which your company may offer to your key employees or key collaborators. By making them part of your company’s ESOP, they will get the option to purchase company shares at a predetermined price, so that in the end they may own a piece of your company. The primary motivation behind ESOPs is to ensure that your employees’ interests align with your company's long-term growth and success.

• Are there more types of ESOPs? ESOPs may take different forms, each with its characteristics. Depending on your decision, you may offer your employees options to purchase company shares at a specific price, grant them actual shares upfront, or give them cash equivalents tied to company stock performance (phantom stock). You could choose one or another based on your company's objectives and what works best for the employees.
• Is anything common to all these ESOP types? ESOPs are not universally applicable to any employee, and often you may decide to restrict them to some categories of employees, based on factors such as job roles, tenure, performance, and individual qualifications. However, vesting is a core principle present in all ESOPs. Vesting represents a timeframe over which employees may gain ownership rights to the granted options or shares. Motivating them over time, instead of immediately, is meant to encourage their loyalty and engagement, as it rewards their ongoing commitment to the company's growth.
• Which employees get to be part of the ESOP? Offering to an employee ESOP participation depends on a combination of factors, which may include their tenure with the company, their individual performance metrics, and sometimes, if they leave the company, their exit status (good or bad leaver). You should define these criteria at company level to ensure that employees who contribute positively to the company's objectives are the ones benefiting from the ESOP.

‍2: Is ESOP better or worse than cash bonuses?

Well, as always, there are advantages and disadvantages to every situation. Although employees may prefer one or the other, typically you should decide on a specific mix of ESOP and cash-based rewards for employees, and then implement this in the compensation packages, tied to specific performance items you consider critical for the company. 

• ESOP advantages. Rewarding your employees through an ESOP may give them several compelling advantages. The value of their options or shares can appreciate over time, providing them with a potential (significant) financial gain. Additionally, ESOPs often come with tax benefits, allowing you and them to pay less taxes, or to pay them later, than if you decide to motivate them through a cash reward (typically both). It may be easier also for the company to give options or shares than cash, as cash is precious to ensure company growth. Furthermore, during equity events such as acquisitions or initial public offerings (IPOs), your employees may stand to realize significant profits from their ownership stakes.
• ESOP disadvantages. Where’s no pain, there may be no gain. Accessing the ESOP’s advantages comes with some requirements that may be difficult to achieve for employees. The main one is the potential need for upfront capital to exercise options or purchase shares. Additionally, there may be a time delay before they can fully benefit from their ownership stake. Furthermore, they will participate to all your company ups and downs, may need to be consulted for votes (depending on the ESOP type you choose). Another aspect is that this adds extra shareholders in your cap table that you need to take care of. Implementing and managing an ESOP requires some paperwork, legal advice, time and energy from a dedicated person or even a team. Luckily, help is at hand by working with providers that can help with all ESOP aspects.

3. Which are the main steps to implement an ESOP in my company?

If you plan to implement an ESOP in your company, you should navigate through the following key phases:

• Design: You should determine the objectives of your ESOP, including the desired level of employee ownership, participation criteria, and the allocation of options or shares. You should make sure that the ESOP plan aligns with your company's growth trajectory and financial situation and goals.
• Documentation: Once you thought out your ESOP, it is time to document is. You must create comprehensive documents outlining the terms and conditions of the plan. These documents should cover aspects such as eligibility criteria, vesting schedules, exercise procedures, and potential adjustments based on significant corporate events.
• Communication: The plan has no value if employees don’t know about it. You should communicate the ESOP to your employees, ensuring they understand the benefits, mechanics, and potential outcomes of participation. You should be as transparent as possible, as this will generate trust and hopefully lead to active engagement.
• Implementation: Now you are ready to launch the ESOP and facilitate the granting of options or shares to eligible employees. This involves the formal process of awarding ownership rights according to the predetermined terms.
• Vesting and Monitoring: Throughout the life of the plan, you should monitor employees' vesting progress and ownership status, and at the same time keep employees informed at all times about their vesting schedules and milestones. As this is a relatively finicky task that should be done right, we think that relying only on spreadsheets and paper files will not be enough.

> Create and manage your ESOP here.

4. How do I grant shares to eligible employees?

• How do I decide how many shares or options to grant? The decision to grant options or shares to employees is typically made by the company's management team or board of directors. These decisions align with the company's goals and the desired employee participation in ownership. Some employees may negotiate how many options they will be granted when they start working for the company, or upon some promotion, but other than that, once decided, the granted stock options packages are likely to remain unchanged.
• So there will be no changes once share options are granted? While changes to granted shares or options are relatively uncommon, they may occur under specific circumstances, such as changes in company structure, regulatory requirements. Also, if employees are getting a new position, or in case of exceptional performance, they may renegotiate their ESOP package. Significant corporate events, such as financing rounds or listings on stock exchanges, can impact the value and accessibility of options or shares. These events can lead to the revaluation of options or shares and may trigger adjustments to the terms and conditions of the ESOP.
• Is there a specific negotiation period? The terms and conditions of granting options or shares are usually negotiated during the employee onboarding process or at specific intervals, depending on company policies. So be sure to include the relevant information in the documents about the ESOP.
• How do employees see the status of their share options? Typically, companies provide their employees with a tool or platform allowing them to track their granted options or shares and ensure visibility into their ownership stake.

Building and managing your ESOP with SeedBlink? All steps in your employees’ participation to the ESOP are visible in their account. 

5: More about Vesting

Vesting is a concept which is always found at the core of any ESOP, as it rewards employees' loyalty and sustained commitment (meaning the company rewards stable and productive employees). By tying ownership rights to their time with the company or performance milestones, vesting should encourage them to remain engaged and contribute to the company's growth.

• Are there more vesting types? There are two primary types of vesting: time-based and milestone based. Time-based vesting will rely on the employee’s length of service, gradually unlocking ownership rights over a predetermined period. Milestone-based vesting, on the other hand, is tied to achieving specific goals or milestones (the employee’s or the company’s), resulting in ownership rights upon successful accomplishment.
• What is a vesting schedule? A vesting schedule outlines the timeline over which an employee will gain ownership rights to the granted options or shares. This schedule is a crucial reference point for the employee, providing clarity on when the ownership rights could be exercised. In some cases (acquisition, investment round, IPO), vesting schedules can accelerate, meaning all the share options still not vested may vest immediately.
• What are vesting conditions? Detailed vesting conditions, including the specific milestones or performance metrics, are usually outlined in official company documents or designated platforms. These conditions provide a transparent framework for employees to see exactly where they are standing in their progress towards ownership.
• Is there a way to present employees their vesting situation? The employee dashboard in specialized platforms show them the granting situation is also allowing them to also see which share options are vested. 

6: How do employees exercise their Options?

• Do employees need to pay to get share options? Exercising options or purchasing shares under an ESOP may require the employees to pay a certain price. This applies to either purchasing the options at the predetermined strike price or directly buying shares. This price may be lower than the market price for the shares, but nevertheless it may represent a significant amount for the employee. For this reason, there are ways in which the employee does not need to advance any cash amounts, but only takes back a difference in the case of a liquidity event for example, making the program more attractive.
• Do employees need to exercise all their vested share options? Typically, employees are often granted the flexibility to exercise only a portion of their vested options, enabling them to manage their financial commitments strategically. So, they could choose to exercise only part of their vested share options, or even none at all.
• Should the employee decide immediately upon vesting how many share options to exercise? The employees are not obliged to exercise their vested options immediately upon becoming eligible. They can choose when to exercise within a specified timeframe, allowing them to consider market conditions and their personal financial situation. However, this timeframe may be limited, so after a while, if they do not exercise them, their share options may be lost. There are also variables that depend on the nature of the company - private/ public.
• Do employees or the company need to pay taxes upon exercising?  When employees exercise their options, purchase or sell shares, there’s some tax obligation attached. However, how many taxes each of the parties should pay and when depends on factors such as the timing of exercise, the difference between the strike price and the market value, and local tax regulations. In each country there are some tax advantages for companies / ESOP members, so be sure to check the specific conditions in your case with your legal and tax advisors. 
• What happens after employees get the shares? Upon exercising options or purchasing shares, employees become partial owners of the company, with the potential to benefit from any future appreciation in share value. If the value of the company grows, their share of the company increases too. If the company does not perform well, their shares may lose value.

7: More questions...

• What happens if an employee leaves the company during the vesting period? Employees who leave the company may have different outcomes for their vested options or shares based on their exit classification. Those deemed "good leavers," typically leaving for reasons such as retirement or amicable departures, may retain ownership rights. "Bad leavers," who exit under less favorable circumstances, may face restrictions on ownership rights or have to relinquish them. However, shares they already own when they are leaving remain theirs under any circumstances, unless somebody else or an entity buys them out.
• Could employees sell their share options? In some cases, the employees may have the option to sell their vested shares or options. However, this is strictly subject to the company's policies, regulatory considerations, and any contractual restrictions. Selling shares on the secondary market can provide employees with liquidity and the opportunity to realize value from their ownership stake.
• How do employees know the value of their share options? Determining the value of options or shares in an ESOP can be complex and is often tied to various factors. These factors include the company's financial performance, industry trends, market conditions, and potential future equity events. Valuation methods may involve the engagement of professional valuation experts to ensure accuracy and fairness. Companies who implement ESOPs usually perform such valuations from time to time, as in some countries this is required by law, while in other countries, even if not mandatory, the company does valuations from time to time for the benefit of the ESOP employees and shareholders.‍

Profit / loss calculation example

Let's calculate your profit or loss if an employee buys ESOP shares in your company under different scenarios. Let’s say the employee buys ESOP shares worth 1,000 EUR, at a strike price of 0.85 EUR at a moment when the company value is 1 mil EUR, and the share price is 1 EUR. We consider the following situations:

1. The company value stays the same
2. The company value diminishes at 900.000 EUR
3. The company value diminishes at 500.000 EUR
4. The company value increases at 3 mil EUR.

Initial Information:

• Current Company Value: 1,000,000 EUR
• Strike Price: 0.85 EUR (The price at which the employee purchases the shares)
• Share Price: 1 EUR (The market price per share at the moment of calculation)

Scenario 1: Company Value Stays the Same

• Profit/Loss = (Share Price - Strike Price) * Number of Shares
• Number of Shares = Invested Amount / Strike Price
• Assuming the employee invests 850 EUR (1000 shares):
• Number of Shares = 850 EUR / 0.85 EUR = 1000 shares
• Profit/Loss = (1 EUR - 0.85 EUR) * 1000 shares = 150 EUR (Profit)

Scenario 2: Company Value Diminishes to 900,000 EUR

• New Share Price = 0.90 EUR/share
• Profit/Loss = (New Share Price - Strike Price) * Number of Shares
• Profit/Loss = (0.90 EUR - 0.85 EUR) * 1000 shares = 50 EUR (Profit)

Scenario 3: Company Value Diminishes to 500,000 EUR

• New Share Price = 0.5 EUR/share
• Profit/Loss = (New Share Price - Strike Price) * Number of Shares
• Profit/Loss = (0.5 EUR - 0.85 EUR) * 1000 shares = -350 EUR (Loss)

Scenario 4: Company Value Increases to 3,000,000 EUR

• New Share Price = 3 EUR/share
• Profit/Loss = (New Share Price - Strike Price) * Number of Shares
• Profit/Loss = (3 EUR - 0.85 EUR) * 1000 shares = 2,150 EUR (Profit)

In summary, the employee profit or loss from buying ESOP shares depends on the change in company value and share price. In Scenario 1, 2 and 4, the employee experiences profits due to increases in company value or share price. However, in Scenario 3, the employee incurs losses due to decreases in company value and thus the share price. Even if the company value decreases, as long as the company share price remains over the strike price, employees win. If the share price decreases below this limit, employees lose.

8: What could SeedBlink do for me?

• Getting started: SeedBlink Equity serves as a comprehensive platform designed to allow effective management of all things equity, including ESOPs, streamlining various aspects of the process for both employees, employers and the company.
• Tracking Options/Shares: SeedBlink provides the company with a centralized view of the granted options or shares. Using the platform keeps you informed about your employees’ ownership status.
• Vesting Schedule Monitoring: You can rely on SeedBlink to monitor vesting schedules. This feature ensures that you are well aware at all times of your employees’ progress toward exercising their ownership rights based on predetermined milestones.
• Facilitating Exercise: SeedBlink streamlines the exercising process, simplifying the steps involved in converting options into shares or purchasing shares at the strike price. This streamlined process minimizes administrative hurdles and decreases time spent on administrative tasks.
• Complete Overview: SeedBlink offers you a detailed view of all ESOPs created in your company. This is designed to allow you informed decision-making and a clear understanding of your employees’ cumulative ownership.
• Secondary Market Access: SeedBlink can also provide your employees in the future with access to a secondary market via SeedBlink Secondaries for buying or selling shares/options. This market offers liquidity and flexibility, and will allow them to manage their ownership portfolio based on changing financial needs or market conditions.

9: What do some key terms mean

• Options: Options represent the right granted to the employee to purchase company shares at a predetermined price within a specified timeframe.
• Shares: Shares denote ownership units in a company. If employees own shares, they have a stake in the company's performance and growth.
• Granting: Granting is the process by which your company allocates options or shares to the employees, outlining the terms and conditions under which these ownership rights are offered.
• Vesting: Vesting refers to employees’ gradual accumulation of ownership rights over time or upon meeting specific performance milestones. Vesting should incentivize them to remain engaged with the company and its long-term objectives.
• Milestone: A milestone is a significant achievement or performance goal that, when met, triggers vesting of ownership rights. Milestones are often tied to the company's strategic objectives.
• Exercising: Exercising involves the conversion of vested options into actual shares or the direct purchase of company shares. This action allows the employees to become partial owners of the company.
• Strike Price: The strike price, also known as the exercise price, is the predetermined price at which employees can purchase company shares when exercising options.
• Good Leaver/Bad Leaver: These terms categorize departing employees based on the circumstances of their exit. "Good leavers" exit on positive terms, while "bad leavers" exit due to circumstances less favorable to the company.
• Secondary Transaction: A secondary transaction refers to the buying or selling of shares/options in a secondary market after the initial granting phase. This secondary market provides employees with liquidity and flexibility.
• Equity Event: An equity event refers to a significant corporate occurrence that impacts the ownership structure of the company. Examples include mergers, acquisitions, initial public offerings (IPOs), and financing rounds.‍

Closing remarks on ESOPs

We hope this guide has allowed you to gain a solid understanding of ESOPs. Now you're better prepared to navigate your journey as a company founder or ESOP manager, and make informed decisions about all the steps you need to design, implement, operate and monitor your company’s ESOP.

For guidance on all aspects of ESOP planning, implementation and administration, check out SeedBlink.