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ESOPs as a Hiring and Retention Strategy

You are a startup looking to hire a senior software engineer with a total of 5 years experience. The market standard of compensation is higher than the budget you have. What do you do? Pay the market standard utilizing your cash reserves or grant stock options and make the employee a part of the startup’s journey?

Traditionally, stock options were only allotted to senior employees (either at the time of joining or later). This notion has changed. The concept of compensating employees only for the services provided has been done away with. Companies are now willing to offer options to all employees rather than a selected few.

Companies have moved towards making employees part of the company’s growth allowing them to participate in the profits of the company.

This has made employees earn returns exponentially making it easy to connect with the younger workforce or new joinees.

How does granting stock options help companies?

Granting stock options to employees can be a valuable tool for startups to attract and retain talent, while also aligning the interests of employees with the growth and success of the company. 

Stock options have proven to be a significant retention tool. Companies often find it easy to attract talent after the successful implementation of an ESOP liquidity plan. This is because the potential hires believe in the growth of the company and feel assured of its ability to attract investors or accumulate funds for a future liquidity programme.

Research suggests that companies see improved performance after issuing stock options, as employees feel a sense of ownership and are motivated to contribute to the company’s growth.

Stock options can also help reduce employee attrition, as employees have a vested interest in the company and are more likely to stay for a longer period of time, saving the company the cost and time spent on hiring and training new employees.

Additionally stock options can help retain employees during difficult economic times, such as when the company is facing cyclical changes or announcing ESOP liquidity programs to compensate for pay cuts

It’s important to note, however, that as the company grows and evolves, the stock option plan may need to be adapted to account for increased number of employees, potential dilution of promoters’ shareholding, or better governance through a trust structure. Therefore, it’s important to review and update the stock option plan regularly to ensure it aligns with the company’s current needs and goals.

Why are employees preferring stock options in today’s times? ​

In the past, most people preferred to work at established companies because they offered more security and higher pay, as well as better benefits such as CTC, bonuses, and perks. Additionally, individuals were less likely to take risks associated with joining a startup. However, this has changed in recent years.

As general awareness and knowledge about stock options has increased, many individuals are now more willing to consider joining startups. Examples of companies like Zomato, Nykaa have given employees the confidence that stock options can generate wealth for them in the long run. Employees also understand that they can become part-owners of the company once they are shareholders. Returns are earned based on the difference in the strike price and the fair market value of shares at the time of exercise. 

In recent times, companies have been actively increasing their option pools, offering buyback or liquidity programs, which has led to a shift in the mindset of many people, including those who were previously risk-averse, to consider joining startups. Stock options create a mutually beneficial situation for the company, employees, and investors. The company benefits from improved performance and high employee morale, while employees are motivated to positively engage with the company due to the potential for wealth creation in the future. This also gives investors confidence that the company has the right resources who are not only motivated by financial compensation but also by the potential for wealth creation.

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