Startup companies, in their infant stages, face uncertainty given the macro cum micro operating environment, availability of continuous stream of funds, ability to make a mark with technological innovations and retain manpower. Employee retention and sustaining their motivation levels has been one of the key concerns for the empoyers of startup firms.
In this regard they always come up with one or the other new innovative and attractive compensation packages structured to target highly skilled niche workforce. Employee stock options (ESOP) and sweat equity are considered to be one of the favourite methods of attracting and motivating talent given the companies are illiquid to pay high salaries and need to utilize the freshly infused funds for growing their business.
ESOP is provided with an aim of empowering employees to partner with the financial outcomes of the firm. Sweat equity, on the other hand, refers to the intangible benefits accrued through non-financial means in the form of employee know-how and niche skills. In certain cases, employers also consider awarding phantom stock options wherein the employees are not exercised to have a direct share of the actual stocks but instead provisioned with synthetic stocks that directly correlate to the financial outcome and well being of the startup firm.
However, employees in the last 2-3 years are inclined towards being compensated in the form of cash incentives and bonuses. In this context, it becomes interesting to find varied thought processes while deciding the benefits both from the employer’s and employee’s perspective.
Valuation, Success and liquidity are major factors
Arriving at the right reward mechanism in case of a startup firm is a confluence of firm’s valuation, success of the business idea in its sphere of influence and liquidity. Stock options permit employees to gain ownership in the company’s business as well as make the employees responsible for their actions for the rise and fall of its financial condition.
Founders and institutional investors consider stock options or sweat equities as dilution of their shareholding pattern. The first 1-3 years of their existence becomes crucial with infusion of funds at regular intervals forming the key. Hence, planning upfront by understanding the future dilution and allocation of shares (pre and post valuation) forms paramount.