Employee Share Option Pool (ESOP)

Explained, examples, and why they're used

Table of Contents

What is an Employee Share Option Pool (ESOP)?

2 Main Types of ESOPs

How do Startups use ESOPs?

What is an Employee Share Option Pool (ESOP)?

The employee share option pool (ESOP) has become a popular way for startups to attract and retain top talent. An ESOP is a pool of shares that are set aside for employees of the company. The size of the pool is typically determined as a percentage of the total number of shares outstanding. For example, if a startup has 1,000,000 shares outstanding and an ESOP of 10%, then 100,000 shares would be set aside for the ESOP.

The main reason why startups use ESOPs is to attract and retain employees. By offering employees the opportunity to own a piece of the company, startups can compete with larger companies that may have more money to offer in salaries and bonuses. Employees who participate in an ESOP typically have the right to purchase shares at a discounted price. For example, if the fair market value of a share is $1 and an employee has the right to purchase shares at a 20% discount, then the employee would only have to pay $0.80 per share.

There are two main types of ESOPs:

restricted stock units (RSUs) and stock options. RSUs are actual shares of stock that are granted to employees. Stock options give employees the right to purchase shares at a future date. The main difference between RSUs and stock options is that RSUs have vesting periods, which means that employees cannot sell or transfer their shares until a certain period of time has passed (usually four years). Stock options do not have vesting periods.

How do Startups use ESOPs?

ESOPs can be used by early stage startups as a way to attract and retain top talent. By offering employees the opportunity to own a piece of the company, startups can compete with larger companies that may have more money to offer in salaries and bonuses. However, there are some things that founders should keep in mind before setting up an ESOP.

First, it’s important to understand how much equity you’re willing to give up in order to attract and retain employees. Second, you need to think about how an ESOP will impact your company’s valuation. If you’re planning on raising money from investors in the future, they will likely want to see an ESOP in place as it shows that you’re committed to attracting and retaining top talent. However, giving up too much equity in an ESOP can negatively impact your company’s valuation.

Third, you need to decide what type ofESOP you want to set up: restricted stock units (RSUs) or stock options? RSUs are actual shares of stock that are granted to employees while stock options give employees the right to purchase shares at a future date. The main difference between RSUs and Stock Options is that RSUs have vesting periods which means that employees cannot sell or transfer their shares until a certain period of time has passed (usually four years). Stock options do not have vesting periods.  It’s important to choose the type of ESOP that makes most sense for your company and your stage of growth.  

Lastly, you need to consider taxes when setting up an ESOP. When employees exercise their options, they will be taxed as ordinary income which is the highest tax rate. However ,if the securities are qualified small business corporation(QSBC) shares ,the employees will be able to pay a tax rate of 0 % on their gains when selling their shares   A QSBC is a corporation within the meaning of the Small Business Act which means it’s listed on an over-the-counter market, or its shares are traded on an equity crowd funding platform.

4,000+ Startups & SMBs from 96 Countries have built financial models on Sturppy

Get our Weekly Business Model Deep Dive, Directly In Your Inbox!

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.