ESOPs are a great way to attract and retain the best talents in a startup at the earliest stages when the business is yet to be profitable or cannot effectively pay the talent standard rates. Though a great offer, it might become challenging in the long run if some costly mistakes aren't avoided.
Employee Stock Options (ESOPs) refer to an employee benefit plan that gives workers ownership interest in the company in the form of shares of stock. In our previous article, we created a guide to help you understand how to issue stock options for African employees. ESOPs are a great way to attract and retain the best talents in a startup at the earliest stages when the business is yet to be profitable or cannot effectively pay the talent standard rates. Though a great offer, it might become challenging in the long run if some costly mistakes aren't avoided. In this article, we shall highlight some common mistakes and how to avoid them when planning stock options for your employees.
Over-Valuation of the Company & Stock Options
Startups need to know the worth of their startup at any given time. An accurate valuation report can help sort this out. Founders often assume the value of their company and either overvalue or undervalue as the case may be which then has an adverse effect on the worth of the stock options. In other cases, founders may not be well-versed in the financial regulations & laws in the jurisdiction they are based in and thus might set the value of their stock options at the same level as the prices of preferred stock. It is important to follow legal processes to guide you through the creation of ESOPs.
No Board Approvals
Rushing to grant stock options to employees before a board sign-off or approval is a huge risk because without approval, the stock options cannot actually be granted and whatever the agreement is will be simply just a piece of paper. Technically, founders have to create an agreement that’s vetted by the board at the early stages of the business either through a meeting or a unanimous written consent. Stock options are then granted based on the clauses that are provided in the agreement. If not done right at the early stages, you might need to reissue these stock options later in the future which can be unbeneficial for your employees in the long run.
Typically when recruitment occurs, employees are granted an offer of employment letter that gives details about their job offer and usually excludes information about the stock options clauses and other relevant information. It’s important to have adequate documentation available that explicitly explains the ESOPs for the employee to avoid legal tussles in the future. The right documentation should include the clauses, vesting schedules/exercise period, and the likely expectations around the expiration/termination of the grant.
Not properly tracking vesting schedules
Your inability to properly track the vesting schedules of ESOPs can affect your cap table and the retention rate of your employees. With Raise, you and your employees can track the schedules properly, their issuance dates and their vesting progress. We also provide proper onboarding & training sessions to help explain the concept of ESOPs properly to employees.
The wrong timing of ESOPs issuance is a huge mistake to avoid. Usually, companies issue stock options before they go public so that they can offer a low exercise price to their employees. If you plan to make your offers after an investor term sheet has been created, the exercise prices might go higher and won’t be favorable for your employee. This can automatically mean a low retention rate for your team and a general lack of interest in working at your startup or contributing to its growth.
Mistakes like the ones listed above can be costly for your organisation. Take advantage of Raise to guide you as you grow your startups. With the Raise platform, you will be able to manage your equity properly, track and monitor changes on your cap table and make preparations for the future.
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