ESOP is not an unfamiliar term for the startup world. Initially, ESOPs were granted to grant reward or show acknowledgment to senior employees but now it is offered to reduce fund-shed or to provide a sense of ownership to employees. ESOPs refer to plans that give employees the right to purchase a certain number of the company's shares instead of salary. This provides the employee with a virtual stake and helps to reduce the risk of the founder. This blog helps you understand everything you need to know before accepting ESOP.
Vesting period: First thing that you need to keep in mind is that ESOPs are NOT SHARES. They only allow you to buy shares at a discounted price after a certain vesting period, which is generally of 4 years. If by any means you quit or get fired before the vesting period, the ESOPs are lost.
Tax calculations: ESOPs are taken as an employee's gain and hence taxed accordingly. But it is important to understand that if you were to dispose of the shares, the difference between the sale price and the fair market value will be subjected to personal capital gains.
Scope of the startup: You also need to take into consideration the scope of the company, whether it can stay in the market for more than 4 years. It is important to know the scalability of the idea and how consistent it can be. If a company whose performance is consistently bad can lead to a risk to the value of ESOPs. The best way to deal with this is to limit a number of stocks that you can buy.
Awareness of chances: You should be aware of all your chances. You should not forget that you will be having the ESOPs of a startup and not a listed company. The company can go public and be acquired. If acquired then the ESOPs are transferred to the acquiring company and the ESOP holders will be allowed to encash a portion of their holdings.
Money matters: ESOPs aren't considered as CTC but you should remember that you will be sacrificing a part of your salary with ESOP. As you are not the direct owner you can always choose between a good CTC and CTC with ESOP.
Agreement terms: You need to go through the agreement terms thoroughly before signing them. A few years ago Skype laid off a few employees. They were not allowed to keep an even vested portion of their stocks due to some clause in Management Partnership agreement, which was not noticed by any employee before signing them. It's a summarization of an article by Anusha Kovvuri.