We have had discussions earlier here on attracting great talent to startups, and what the key motivators are. Clearly, there are other motivators besides money in a startup decision – such as sense of purpose, role that one can play, and so on. However, the more I talk to entrepreneurs around, the more evident is the lack of a financial incentive that works.
Couple of weeks back, I was in a group of entrepreneurs for a closed-door discussion on this. There was near unanimity that employees do not value ESOP grants. There were still some people who were allocating ESOP, especially to early/core team, but with very little conviction. One of the things that also came up was whether the entrepreneurs themselves understood this well enough and believed that it can make a difference.
In my opinion, the key gap is in building a perceived value around this tool. It is about highlighting and celebrating successes. Early/core employees need to believe that if this thing works, they can make far more than they will ever earn (yes, even after accounting for high salary increases that we all experience). Towards that end, it will be good to get some success stories in response to this thread, where key employees have landed up making significant returns through ESOP in startup situations.
Also, would love to hear people’s thoughts on alternate incentive mechanisms that serve the purpose. In my opinion, the key attributes that such a mechanism must satisfy are:
- Alignment with value creation objectives of shareholders
- Retention effect/ Accumulation effect of rewards
- Ability to attract distinctly better talent, especially against large companies
- Performance orientation
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ESOP being a “deferred compensation” (book keeping term), it builds an expectation of certainty of occurence. If the startup doesn’t fly, the option holder gets nothing – that prospect takes away its appeal to hires.
Any alternative mechanism has to address this risk and offer some consolation. Some suggestions –
a) Founders must share knowledge & experience at a fundamental level;
b) Offer hands-on training in latest tech which would have been either not easily available or would’ve been phenomenally expensive;
c) Meaningful cross functional exposure in Marketing,Finance,Legal for a techie. Take him to bank while exploring working capital limits with bankers, while talking to IP attorneys, finalising channel partners or franchisees, vendors and marketers.
To make ESOPs appealing, start by being considerate – If the employee leaves the company after a reasonably long period of time, say 3 years, provide for some calibrated buyback at slight premium to issue price. This gives some meaning to ESOP and gives other holders a benchmark valuation when intrinsic valuation norms don’t apply.
For attrition control, deliver honest value addition to a low profile hire. Spend some time training them. Look for people with the right attitude (with an instinct to learn and in need of a job) than an aptitude. After all every gem is a polished rock. Such talent won’t easily show up in the big co HR radar and even if they do, it will be way below their dignity for the suits to even recognize their existence.
I made some teensy weensy money with ESOPs in my last company as we got bought out, and earlier I was a founder in a startup that gave me a decent exit. But I’m in the process of spending it all on my next venture so it’s going to be is haath de, is haath le. So I don’t count.
Who does? Infy ESOPs probably don’t count but if it does: people from my college who joined Infy in 94 and all became, whatchamacallit, rich. 10 cr.+ types. A good friend who joined Cognizant before it went public would’ve joined the gang but decided to pursue other things. That would be an awesome story.
Mindtree employees got rich for a few days. Naukri, I don’t know – that stock has tripled – but the founders own most of the stock. Firstsource has had options but it’s stock is languishing too. Tech Mahindra employees would’ve done reasonably well.
Private buyouts – there’s not much info and I dont’ think any spectacular exits have happened that make people more than a few crores. Maybe Indiaworld/Rajesh Jain is an exception.
Alok, did any of the folks in Jobsahead have any options, and did anyone get big moolah?
Is there a really big exit where options could have come into play? All i hear about are Indian companies acquiring companies abroad, or companies abroad acquiring companies abroad. Who’s acquiring Indian companies?
I agree ESOP do not seem to work in India. How many successful exits have we seen that can impress the potential employee. Then of course there is the FBT.
I believe ESOP’s should be restricted to top management only CXO category. Even then it has to come at a price far greater than what the founders paid but lower than the VC valuation. This will ensure a firm commitment and alligence to the company and its vision. I think Brin & Page set the right example and we should value that.
I believe that in a start up that wants to attract the best employees, the ESOP would tend not to be a significant deal creator between the company and the potential employee unless there is reason to believe that the pot of gold has a credible external agency evaluating it. That belief could come if there is a VC knocking at the doors . For example, I have experience in recruiting for a start up where the Rs 10/initially allotted Founder shares were being evaluated by a VC at Rs 60 for their entry…while senior employees joining at the post incubation phase were being offerred shares at Rs 33( which they had to buy–no ESOPs). The diff ( 60-33) could then be looked at as value already created. The potential candidates had access to the business plans which were being evaluated by the VC …..In this case, they had traded off their salaries for lower joining salaries — but were also offerred large bonuses in 12-18 mths based on the companys performance . The bonus slabs were linked to targets and in a stretch-achievable scenario, the monthly Cash Comp + Bonus exceeded the total Cash Comp earned in the earlier job.
If employees have traded off their existing salaries and jumped into a start-up, they would not do so merely because of an ESOP and the chances of its success in future. A strong belief in the idea, in the Founders and belief that the joining person could make a difference would be the essentials –and the ESOPs could help to clinch the deal. But if the ESOP is offerred along with a requirement to work for significantly lower Cash Comp, that perhaps would not attract the best talent unless offset by compensatory large incentives/bonuses in a medium term.
Far bigger issues in making ESOPs work are
– Management’s indecisiveness (stinginess?) in getting the options plans and allocation done quickly and being transparent about its communication. This is a perenial problem in India. Founders and managements dilly-dally on ESOPs like there is no tomorrow. This is case with 8 of 10 companies and that’s the CHIEF reason employees have given up on ESOPs. In US when I was made an offer by a VC funded startup, the ESOP allocation got done in 2 days, was approved by VCs in another 2 days, and communicated to employees in writing in next 2 days.
– FBT made ESOPs completely ridiculous from a tax perspective. Somebody should hang the babu in finance ministry who came up with the idea of taxing ESOPs. When an employee or cofounder takes a 50%+ paycut in lieu of ESOPs, only he/she knows what he goes thru. Taxing ESOPs kills the whole game for him.
– To add, founders and VCs want to keep all voting control of ESOPs in their hands, as if employees are planning a secret mutiny using their meager shareholding. This delays and complicates ESOP plans further, making them less and less attractive.
Bottomline to managers and VCs on ESOPs: Be generous, be simple, be quick, be decisive, be fair, communicate quickly, timebox the whole thing, do not sweat the small stuff.