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Wealth creation through ESOPs

Engaged in our discussions, we never realized that it was 10 p.m. I was about to leave, when Ranveer questioned me, “Are ESOPs for real?”

I could gauge the confusion in his mind and heart – the mind was convinced about the benefits of ESOPs but the heart was still not ready to believe that ESOPs could lead to wealth creation.

In this Part VI of the ESOP Series – Wealth Creation through ESOPs, I quickly worked on some numbers for Ranveer to absorb and decide how ESOPs can lead to wealth creation.

Investing in ESOPs

An example below would make it more evident. Let’s see what happens if your employee invests Rs. 100,000 in different investment instruments. We see that the returns from ESOPs are exponentially higher than investment in fixed deposits, equity instruments like shares and mutual funds and angel investments. The numbers assure of the possibility of wealth creation through ESOPs.

Base Amount (INR)1,00,000
Maturity (in years)7
InstrumentCAGR (assumed)Value at Maturity
Fixed Deposit7%1,60,578
Equity shares20% 3,58,318
Angel investment 32% 6,98,261
ESOPs 122% 2,65,74,850

ESOPs can generate wealth in a single year or over a period of time depending on the Vesting Structure. Generally, the Vesting Schedule is spread over a period of 4-5 years after the Grant. It can also be used as a retirement planning instrument.

Risks involved

Like any other equity instrument, investment in ESOPs carries a risk. The quantum and periodicity of returns is uncertain. The investment tends to be locked-in for a long-term. Further, some stock option plans may not be successful. Nevertheless, if an employee has faith in the company, it is worth taking the risk.

The risk is higher when the company is an early age startup or has just completed the Seed funding or Series A funding round. If an employee exercises Grants at this stage, there is a high risk involved. However, the plausibility of high returns is also very high.

As the company enters the growth stage, every subsequent round of funding assures the employees of the growth potential of the company. This lowers the risk; thus, prompting more and more employees to exercise their Grants. Investment at this stage carries slightly lower risk. The returns may also be lower than the returns generated by an employee who acquires the Grants at an early stage.

Risk and reward are two sides of the same coin. Employees are not obligated to exercise the Grants. They may take a call about what suits them the best.

Our discussion convinced Ranveer about the possibility of wealth creation through ESOPs. 

Post all conversations that we had on ESOP, Ranveer was finally ready to take the plunge!

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