Attracting and retaining top talent is crucial for any startup's success, and Employee Stock Ownership Plans (ESOPs) are one of the most powerful levers you can pull to attract, retain and motivate staff.
However, there’s a lot of variability in the design and structure of these programs based on the different cultures and compensation philosophies of organisations. This means communicating the value of ESOPs to employees can be a minefield, as there is no hard and fast playbook on how to do it.
To help, we hosted a forum for our portfolio with Jason Atkins, President at Cake, and Simon Baume, COO at Eucalyptus, to pull together best practice principles for communicating the value of your ESOP to employees. Here's what we learnt:
Using salary and ESOPs to attract, retain and motivate staff
Before we dive into how to communicate your ESOP, it’s important to understand the purpose of salary and equity in compensation programs. For talent, salary is more universally understood and easy to compare between offers, whereas equity can be more confusing. Equity is usually given for three reasons:
- It’s a “cheaper” form of compensation. Equity can serve as a “cheaper” form of compensation than salary, particularly for early-stage startups where capital can be scarce.
- To compete with salary-based offers. Equity allows you to make your offer more competitive for prospective staff when you can’t compete with other salary-based offers.
- To motivate retention and ownership mindsets. Equity helps align employee interests with company goals, and can increase retention as staff work toward reaching their vesting period.
Why are ESOPs often misunderstood or undervalued?
There are a few reasons why ESOPs are misunderstood or undervalued by employees:
- ESOP complexity. ESOPs are complex by nature, with companies having different program designs, valuations, share pricing and rules. Additionally, if employees haven’t participated in one before, they likely won’t be able to assess its potential value.
- Tax implications and valuations. The valuation, tax, legal, and HR considerations related to ESOP add an extra layer of complexity, with tax implications often being a big source of concern.
- Lack of exits or visibility of exits. When employees are considering an ESOP, they want to see a clear path to realising the value of their shares. Without visibility, employees may be less willing to commit to a long-term investment.
- Confusion when employees reach the end of their vesting period. If employees reach the end of their ESOP and there aren’t clear next steps, it can cause a drop in motivation.
Ways to communicate ESOP value to employees
The good news: effective communication can resolve much of the confusion around ESOP.
We’ve broken down the most important ways to communicate ESOP value into two categories: offers and onboarding, and financial modelling and exit event scenario planners.
Offers and onboarding
Embedding an understanding of ESOP right from the offer stage is the best way to ensure employees value it and are motivated throughout their vesting period. While you may be inclined to present equity as a $ offer, this misses the point that future exit scenarios determine the ultimate value for an employee. This can result in incorrectly setting employee expectations and potentially falling into the realm of financial advice. You should avoid phrases like:
🙅 We’re giving you x% of the company
🙅 You’ll receive $x worth of shares or options
🙅 We’ve converted x% of your salary into equity
Instead, you should provide clear verbal and written explanations of the key terms of your ESOP (including exercise price, vesting schedule, vesting conditions and exit events) in offer letters and when onboarding new staff.
To ensure that all current employees are equally well-informed about the value of the ESOP, you should conduct a session to bring everyone up to speed. Here are some questions to proactively answer at the offer and onboarding stage (and in a session for current employees):
👍 What is an ESOP?
👍 Why do we have an ESOP?
👍 What is vesting?
👍 What is your vesting schedule and conditions?
👍 What’s an exit event and what’s the company’s current outlook?
Financial modelling and exit event scenario planners
Financial modelling and exit event scenario planners simplify the complexity of potential ESOP outcomes into clear data. Providing models and planners to employees increases transparency and gives context on how you’re thinking about the company’s future outlook. As an example:
In the above table, the scenarios are directly linked to a recent raise amount and equity value. This gives employees a chance to see their equity’s value across a range of different outcomes, and importantly, the outcomes are made more real by their link to a recent raise amount. You’re also acknowledging the lowest potential outcome ($0) and you haven’t committed to an outcome, nor to how much their equity is worth in $. Instead, you’ve provided them with a tool to understand how their ESOP works.
ESOP value and salary package calculator
To help, we've created a financial ESOP model template which includes a value calculator, salary package calculator and vesting schedule. Click the link at the top of this article to access it.
Minimum amount of ESOP information to share with employees
Worried about sharing too much? You don’t have to tell your employees everything, but there are a few things you should share to ensure they understand ESOP and its value.
- Summary of plan rules. Including the exact number of options, total shares on issue, vesting and exercising rules, and what happens when they leave.
- Value. Use all-hands updates to educate employees on exits, secondaries, dividends, and the value of their equity.
- Forecasting tools. Provide simplified summaries of ESOP in company and employee guides, forecasting tools to show employees what their equity is worth, and education on the tax implications of equity compensation.
- Business plans and priorities. Employees need to understand the factors contributing to the company’s value and what must occur for an exit event to happen.
- Potential risks. Employees should also know that equity is speculative, and their options may not eventuate or be worth their maximum potential value.
How do you navigate ESOPs with changing valuations from both a technical and communications perspective?
From a technical perspective, it's crucial to grasp the impact of changing valuations on ESOP and be ready to communicate the potential effects to employees.
It's essential to inform employees about any changes in valuations, valuation goals, raise goals, secondary goals, and important dates. ESOP options typically have a 15-year expiry and allow employees to buy stock at an agreed price in the future, making them attractive to employees who believe the company is expected to grow and exit at a price greater than the exercise price.
A change in valuation, especially a negative outlook, may cause employees to consider why they’re working for the company. When this happens, companies should focus on a long-term outlook and share any future planning with employees to reduce impact.