There are many instances where a new startup founder promises ESOPs to employees when they join; this is typically a verbal commitment or might even be captured on email - that's about it. But this is by no means enough to actually get started because the vesting of options cannot take place unless all the ESOP related paperwork such as scheme documents, vesting schedule, and board/AGM approvals are in place. Also, typically an ESOP pool itself is created only after the first funding round, and it's from this pool that the actual vesting of grants can occur.
How to calculate grant details for employees if the formal ESOP Scheme got approved later
Now, since the granting of options and grant dates can only come after the date of scheme approval (usually a board decision), how can startups handle such cases? Let's look at an example:
An employee named Amol has been promised ESOPa the day he joined a startup. On the joining date of Sep 1, 2018, a total of 100 options were promised to be granted to him with a 4-year annual vesting and 12 months cliff, and this was documented in an email. The vesting schedule as promised to Anmol would look like this:
- Sep 1, 2019 - 25 options
- Sep 1, 2020 - 25 options
- Sep 1, 2021 - 25 options
- Sep 1, 2022 - 25 options
The board/AGM approved the ESOP scheme only on Apr 1, 2019 - so the "actual" grant letter can be given to Anmol only after this date. So what can be done to remedy the situation because there might be a three-year delay in Anmol getting any vested options?
Using bullet vesting
What will help to a certain extent is to give Anmol a bullet grant for the vesting that is due to him till the scheme approval date of Apr 1, 2019, and after that, the remaining options can be granted over a new three-year vesting period. So Anmol's vesting schedule will now look like this:
- Bullet grant on April 1, 2019 - 25 options (Note: These will vest in one shot on April 1, 2020)
- Normal grant on September 1, 2019 - 75 options with a 3-year vesting period
- Sep 1, 2020 - 25 options
- Sep 1, 2021 - 25 options
- Sep 1, 2022 - 25 options
How is bullet vesting different?
Essentially, bullet grants work in a single shot, and vesting is not staggered but completed in one instance itself. Now, let's look at the pitfalls of not having a formally approved ESOP scheme and ESOP pool before ESOPs are "promised" to employees. In the above example, the first vesting of 25 options is clearly getting delayed. This is because Anmol's options are vesting on Apr 1, 2021, instead of Sep 1, 2019, as promised. If he leaves after Sep 1, 2020, but before Apr 1, 2021, he will lose all 25 options. Sadly, this is the price an employee pays when ESOP paperwork gets delayed. It is, therefore, advisable for all startups to use an end-to-end equity management product and formally grant options to employees from Day 1 itself.
At trica equity, we have brought down the cost of granting ESOPs to zero for early-stage startups.
Check out Trica equity - a comprehensive SaaS product that will help you digitize your equity stack - your Cap Table and ESOPs.
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