ESOP or Equity Compensations Plan, a mechanism to render ownership interest to Employees in an Organisation, is already a widespread practice in the Western world. In India, thanks to the growing start-up ecosystem, ESOP is steadily gaining the momentum and the required attention.
ESOP, at its core is implemented to drive outcomes like retaining resources, rewarding for loyalty, enhancing performance and replacing cash component in their compensation.
However, implementation of ESOP does not automatically guarantee the accomplishment of these targeted outcomes. There are important factors that determine whether the ESOP implementation in an Organisation, ultimately turns out to be a hit or a miss. Here is a brief collation of such important factors:
- Employees’ faith in philosophy of the Organisation: ESOPs rewards are linked to the growth of the Company. If the Company fails to achieve the targeted growth or valuation, an ESOP program will not be of any significance to the Employees. When the Employees do not believe in the philosophy of the Organisation, it would compromise on the required effort from their end to grow the Organisation and thus not building any value into ESOPs. Therefore, it is an inter-dependent process where the Employers need to instil faith in Employees about the growth trajectory and core values, also Employees need to have faith in the Organisation’s vision.
- Quantum of Benefit being granted as ESOPs: While granting ESOPs, there could be a failure to evaluate the quantum of benefit to offer. In absence of an optimal benefit offered, Employees tend to get lured by lucrative compensation packages from other companies, which outweighs the ESOPs offered in the current Organisation. A detailed study of the Industry compensation practices, current compensation w.r.t criticality of resources and time horizon of the ESOP plan, could help in determining the adequate benefit to be offered as ESOPs.
- Fairness of Management and commitment towards Employees: It is observed that quite a few Companies commit ESOPs but delay the actual implementation and grant. Such delays fail to generate the intended impact of ESOPs. Clear measures should be taken by the Management, to ensure the Employees continue to believe the fairness in policies pertaining to selection of Employees for ESOP grants, providing right opportunities for settlement of ESOP and at a valuation which is both fair and acceptable. Lack of these measures lead to distrust in Employees towards an ESOP program implemented by the Management.
- Effective Communication: ESOPs being relatively complex and difficult to understand vis-a-vis other components of compensation; it mandates simple, effective and regular communication by the Management to the Employees. Success of ESOP program largely depends on how well Employees understand the modalities of ESOP, valuation methodology, current valuation, , the growth forecasts, the value creation in future.
- Market Conditions: Occasionally, the prevailing economic conditions and Industry sentiments could also have a significant bearing on success or failure of ESOPs for an Organisation. When the Industry or economic situation is not very encouraging, Employees tend to lose faith in the ESOPs being granted (either in lieu of current pay cuts or to provide rewards of future appreciation). Value of ESOPs granted earlier might also erode because of the recession and render them underwater. Management should consider measures to modify the Plan to reinstate value in ESOPs, for e.g. repricing and extension of exercise period.
- Matching of Objectives and Plan Design: It is necessary for an Organisation to identify and prioritize the objectives it would like to achieve by implementing ESOPs. ESOPs lose the ground in case of a mismatch in the expectations of Management or Employees and the ESOP Design. At inception of structuring the Plan, each Company should analyse the alternatives and adopt the best structure that would work for its unique ecology.
Organisations should lay the foundations of their ESOP program after consideration of above points, to ensure greater chances of success.
Neha is a Chartered Accountant , working with ESOP Direct as a consultant in Equity Compensation Solutions team since 2015 .
View her detailed profile on LinkedIn at https://www.linkedin.com/in/neha-prasad-b9765957/