Why are ESOPs preferred by Startups?

Starting a business nowadays becomes easy but it is hard to grow them and make an identity in the market especially for startups. However, startups in India are now opting for ESOPs to attract a talented team of employees. ESOPs help startups to make employees stay at least for 3-5 years commonly known as vesting period. Apart from this, there are many other reasons which make startups choose ESOP. In this blog, we will discuss what is ESOP and why are ESOPs preferred by Startups in detail. 

What is ESOP? 

ESOP (Employee Stock Ownership Plan) is a benefit plan for the employees to gain extra income other than their fixed salary. Employers offer their employees a chance to become a partial owner in the company they are working in the form of direct stock or profit sharing plans. This helps the employers to motivate their employees to stay longer within the company along with enhanced productivity. Usually, people find ESOP Process quite difficult as it is followed by two structures: Direct Route & Trust Route. While startups are focusing more on ESOP and opting it for their business as it helps startups in boosting their business. However, there are multiple reasons why ESOPs are preferred by Startups, let’s understand them in detail. 

Why are ESOPs preferred by Startups? 

ESOP is one of the preferred plans by most of the startups in India as it offers multiple benefits not just only to employees but also for startups. Here are some major advantages why startups opt for ESOPs: 

1. Attract Top Talent: Startups usually adopt ESOP within their company to attract top talent. Startups are new and usually small in size thus sometimes unable to meet the corporate packages to its employees. Offering ESOP is more than just a bonus which can help in attracting top talent for startups as for professionals getting a piece of a startup is a motivating and exciting idea. 
2. Employees Retention: Any startup needs loyal and long-term employees for its success & growth. In order to make employees stay for a longer period, startups offer ESOP. Employee stock ownership plans not only come with shares or ownership but also brings a vesting period. Employees are not allowed to use ESOP before the vesting period which directly motivates them to stay and work harder for the startup business. 
3. Culture Building: Once employees accept ESOP, they naturally become a part of the startup and get a sense of ownership. This ownership brings responsibility and a common goal/target to achieve for the company's success. ESOP helps in fostering a chance to work in a collaboration and for a shared vision. 
4. Conserve Cash Flow: Startups at their early stages usually have limited cash but multiple purposes to use it including operations, marketing, development, salaries, etc. Some startups offer ESOPs to their employees instead of any fixed salary. This method helps startups to conserve the cash flow from salaries. Later, this cash can be used for operations, development, marketing, etc by the startups.
5. Improved Accountability & Innovation: When ESOPs are offered among employees they use to think and act like owners. This mindset of being the owner of your startup improves accountability and brings more innovative ideas for business growth. Also, employee stock ownership plans help in improved quality & teamwork. 
6. Chance to get more Investors: ESOP indirectly highlights that startups value their employees and maintain a mature scalable business structure. A well maintained business structure helps investors to invest in such startups as the employees are committed to stay longer in the startup. 
7. Easy Exit for Employees: Startups offering ESOPs can make an easy exit for their employees without any work blunder. Employees get their equity over time based on their work performance. This helps in ensuring, dedicate and value added work has been submitted by the employee. 

How to Setup Employee Stock Ownership Plan?

ESOP can be set up either by Trust or Direct Route. Following is the concise step by step procedure to set up Employee Stock Ownership Plan:

• Step 01: Draft ESOP Structure
• Step 02: Preparing Article of Association
• Step 03: Taking Board Approval
• Step 04: Shareholder Resolution
• Step 05: File MGT-14
• Step 06: Maintain ESOP Register
• Step 07: Grants of Option
• Step 08: Acceptance & Vesting Period
• Step 09: Exercise of Options
• Step 10: Sale of Share

For detailed procedure, check out this complete guide on Setting Up ESOP in Indian Startups!

Conclusion

Focusing on ESOPs for startups is one of the best ideas for its business growth. ESOPs work more than just a benefit plan for startups as it is one of the strong growth strategies. ESOPs attract passionate & professional talent and retain employees for a startup offering them a chance to conserve the cash flow. Also, startups use to opt for ESOPs as they help raise funds through investors. ESOPs help startups with multiple innovative ideas and accountability along with a sense of teamspirit. All these are the reasons why ESOPs are preferred by Startups.