Should Your Startup Have an ESOP?

In the fight for really good employees, it’s getting harder and harder to compete.  Startups do have a secret weapon though when competing for talent with big businesses - an Employee Share Scheme (ESOP).  More startups are implementing Employee Share Schemes to attract and reward talented staff.


What is an ESOP?


An ESOP is a plan to grant partial ownership of the startup to current or prospective staff.  The schemes themselves can be really simple, or really really complex, and while there is no off the shelf package, the range we see usually fall within a few categories:


  • Employees purchase shares outright
  • Employees are granted share options
  • Shares are held on trust for the employees until a liquidity event
  • Employees are granted partially paid shares


Why have an ESOP?


An ESOP gives employees ownership of the startup, which can lead to higher performance and greater buy in for company decisions.  It can also lead to greater retention of staff as they are owners of the shares, and want to contribute to improving the company’s value.


What are the tax consequences?


All these categories above have different tax and management consequences so please discuss with your advisor prior to beginning the process of establishing an ESOP.    Shares or options can be transferred at market value, discounted or no cost, all of which have different tax consequences.  


What are the business consequences?


There are also other business issues to consider, and its useful to do some scenario planning with your finance professional to determine what will happen in the following circumstances:

  • If an employee leaves
  • If the company sells out
  • If the employee has to pay tax
  • If the company goes into liquidation


Regarding complexity, you’ll also want to consider the cost of establishing such a scheme with the benefits.  You could easily chew up the legal fees on a complex system, money that may be better spent elsewhere in your startup.


Overall we think an ESOP can be a really good alternative for startups and growth firms to compete in the fight for talent.


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