(Saturday Deep Dive) - The Rise of ESOPs in Driving India’s Startup Growth

In today’s deep-dive, we will explore the fascinating world of ESOPs and their pivotal role in the Indian startup ecosystem. As a tool that bridges the gap between limited cash reserves and the need to attract top talent, ESOPs have transformed the way startups incentivize and retain their workforce. From understanding the mechanics behind ESOPs to examining their impact on employee motivation and company culture, this report provides a comprehensive look at how shared ownership fuels innovation, loyalty, and long-term success in fast-growing startups.

What Are ESOPs?

Imagine this: you’re part of the first few employees at a budding startup. The excitement of building something extraordinary is palpable, but the resources—especially cash—are limited. One day, the founder approaches with a proposition: "We can’t pay you as much as the tech giants, but we can offer you something even more valuable—a share in the company’s future success."

This is the essence of Employee Stock Ownership Plans, or ESOPs. These plans promise employees a piece of the company in exchange for their commitment and hard work, aligning their interests with the startup's long-term vision. ESOPs are not just another compensation mechanism; they represent a shared dream of growth, prosperity, and transformation.

At their core, ESOPs allow employees to own a slice of the company. Instead of offering immediate cash—which startups often lack—they provide the opportunity to buy shares at a pre-determined price. As the company grows, these shares may multiply in value, giving employees significant returns.

Consider ESOPs as seeds planted in fertile ground. They might start as small, intangible promises, but with time, effort, and growth, they can flourish into significant financial rewards. For employees, they represent not just a job but a shared stake in the company’s future.

In India, ESOPs gained prominence as the startup ecosystem matured. Companies like Flipkart, Zomato, and Swiggy have used ESOPs to attract top talent when they couldn’t compete with industry giants on salaries. However, understanding ESOPs requires peeling back their layers, examining their structure, and considering their potential.

Features of ESOPs

While ESOPs might sound straightforward, their structure is carefully crafted to balance the interests of employees and employers. Here’s a closer look at the defining features of ESOPs:

1. Vesting Period

When startups grant ESOPs, they rarely give all the shares upfront. Instead, shares are distributed over a specified period through a process called vesting. For example, if the vesting schedule is four years with a one-year cliff, employees need to complete at least one year to access the first chunk of their shares. The remaining shares are vested incrementally over the next few years.

This ensures employees are incentivized to stay and contribute to the company’s growth. It also aligns their rewards with the startup's long-term success.

2. Grant Price

The grant price, also called the exercise price, is the price at which employees can buy shares. Typically, this is set at the company's current valuation or a discounted rate. As the startup grows and its valuation increases, the difference between the grant price and the market price becomes the employee’s profit.

3. Exercise Period

Once the options vest, employees must decide when to convert them into actual shares. This process, known as exercising options, has a deadline. Miss it, and employees risk losing their vested options.

4. Lock-In Period

Even after exercising options, employees might face restrictions on selling their shares immediately. Known as the lock-in period, this ensures that employees remain aligned with the startup's future.

5. Tax Implications

ESOPs come with tax obligations. In India, employees may owe taxes when they exercise their options and again when they sell the shares. Proper financial planning is crucial to navigating these costs.

6. Liquidity Events

The true value of ESOPs is realized during liquidity events, such as IPOs, acquisitions, or buybacks. Until these events occur, ESOPs remain promises on paper.

7. Performance-Based Rewards

ESOPs directly tie employee benefits to the company's growth. If the startup thrives, so do the employees. However, if the company stagnates or falters, ESOPs may not deliver significant returns.

The Role of ESOPs in Startups

For startups, ESOPs are more than a compensation strategy; they’re a cornerstone of growth and culture. Startups operate in fast-paced, competitive environments where talent retention is critical. ESOPs serve as a bridge between limited cash resources and the need to attract and motivate skilled professionals.

1. Attracting Talent in a Competitive Market

Startups rarely have the financial muscle to compete with established companies when it comes to salaries. Yet, they must recruit individuals who can thrive in demanding, fast-paced environments. ESOPs act as a great equalizer by offering prospective employees something that many larger companies cannot: the potential for significant financial upside tied directly to the company’s success.

For young professionals, ESOPs are not just compensation—they are an investment in their future and a testament to the belief in the startup's vision. In India, startups like Zomato and Swiggy have used ESOPs to woo high-caliber talent, demonstrating that shared ownership can be as compelling as monetary rewards.

2. Motivating Employees to Think Like Owners

ESOPs change the narrative for employees. Instead of viewing themselves as mere workers, they begin to see themselves as stakeholders in the business. This psychological shift fosters deeper engagement, as employees become personally invested in the startup’s success.

Ownership encourages employees to think beyond their immediate tasks and consider the broader implications of their work. They’re more likely to collaborate effectively, suggest innovative ideas, and take proactive steps to address challenges. This culture of ownership is vital in startups, where every contribution can significantly influence outcomes.

3. Retaining Talent Through Long-Term Incentives

The structure of ESOPs inherently encourages loyalty. With vesting schedules that spread over several years, employees have a clear incentive to stay with the company for the long term. For example, a four-year vesting period with a one-year cliff ensures that employees commit at least one year before receiving their first allocation of shares.

This retention mechanism is particularly crucial during critical growth phases, when losing key team members could derail progress. By aligning employee rewards with tenure and performance, ESOPs help startups build stable, dedicated teams capable of weathering challenges.

4. Managing Cash Flow and Preserving Resources

For early-stage startups, cash is often the scarcest resource. Every rupee saved can be reinvested in scaling operations, developing products, or marketing initiatives. ESOPs allow startups to offer competitive compensation packages without depleting their financial reserves.

Instead of paying high salaries upfront, startups can allocate equity to employees, ensuring that everyone shares in the benefits of the company’s growth. This approach not only conserves cash but also creates a shared sense of responsibility for the company’s financial health.

5. Attracting the Best Advisors and Senior Talent

ESOPs aren’t just for employees—they’re also an effective tool for attracting high-value advisors, consultants, and senior executives. For example, startups may offer equity to experienced professionals who can guide them through critical decisions, provide strategic insights, or open doors to funding opportunities.

Offering ESOPs to such individuals allows startups to tap into a wealth of expertise without straining their budgets. It also ensures that advisors and senior talent have a vested interest in the startup’s success, aligning their efforts with the company’s objectives.

6. Leveraging ESOPs as a Branding Tool

A well-structured ESOP program reflects a forward-thinking, employee-centric culture. Startups that prioritize shared ownership send a powerful message to prospective employees, partners, and investors: they value their team and are committed to building a collaborative ecosystem.

Companies like Flipkart and Zerodha have used ESOPs not only as a compensation tool but also as a branding strategy. Stories of employees achieving significant financial success through ESOPs enhance the startup’s reputation, making it an employer of choice in a competitive market.

7. Facilitating Talent Retention Post-Liquidity Events

Startups often face the challenge of retaining talent after significant liquidity events, such as IPOs or acquisitions. Employees who suddenly receive large payouts may choose to leave, seeking new opportunities or pursuing personal goals.

To mitigate this risk, startups use staggered vesting schedules or post-exit incentives tied to ESOPs. By structuring equity allocations to reward long-term commitment, startups can retain critical talent even after transformative events.

8. Aligning Interests Between Employees and Founders

ESOPs align the interests of employees and founders by creating a shared vision of success. Founders are motivated to grow the company, and employees are incentivized to contribute actively, knowing that their financial rewards are directly tied to the company’s performance.

This alignment reduces potential conflicts and fosters a collaborative work environment. Employees feel empowered to take initiative, and founders benefit from a team that is as invested in the company’s growth as they are.

9. Attracting Venture Capital and Investors

Investors value startups with well-structured ESOP programs. These programs demonstrate that the company has a solid plan for attracting and retaining talent, which is critical for long-term growth. Additionally, ESOPs signal that the startup is serious about building a sustainable team, a factor that reassures investors about the company’s ability to execute its vision.

Venture capitalists often recommend expanding ESOP pools during funding rounds to ensure startups remain competitive in the talent market. By aligning equity incentives with strategic goals, startups position themselves as attractive investment opportunities.

Benefits of ESOPs for Employees

For employees, ESOPs offer a unique blend of financial and emotional rewards:

1. Ownership

ESOPs transform employees into stakeholders, giving them a tangible connection to the company’s success. This sense of ownership fosters pride and loyalty.

2. Potential Wealth Creation

The upside of ESOPs can be extraordinary. Employees at companies like Flipkart and Freshworks have walked away with life-changing payouts during liquidity events.

3. Alignment with Long-Term Goals

ESOPs encourage employees to think beyond immediate tasks, focusing on the company’s growth and their role in it.

4. Retention Incentive

The vesting structure rewards employees for staying with the company. This creates a win-win situation where employees grow alongside the startup.

5. Low-Risk Opportunity

Unlike direct investments, ESOPs do not require employees to invest significant amounts upfront, making them a low-risk way to participate in the company’s growth.

Challenges of ESOP Implementation

Despite their potential, ESOPs come with complexities:

1. Tax Burden

In India, ESOP holders face taxation at the time of exercising options and again when selling shares. This double taxation can diminish net returns.

2. Liquidity Uncertainty

The value of ESOPs hinges on liquidity events. If a company doesn’t go public or get acquired, employees might struggle to monetize their shares.

3. High Exercise Costs

Employees must pay the grant price to exercise options, which can be financially challenging, especially if taxes are factored in.

4. Missed Deadlines

Strict timelines for exercising options can lead to unclaimed ESOPs, leaving employees without rewards despite their contributions.

5. Complexity

Understanding terms like vesting, grant price, and liquidity events can be daunting for employees, leading to underutilization of ESOPs.

ESOP Success Stories in India

India’s startup ecosystem has seen remarkable growth over the past decade, and ESOPs have played a critical role in this journey. These success stories not only showcase the transformative potential of ESOPs but also highlight how startups can create immense value for their employees while fostering a culture of ownership and loyalty. Here are some standout examples that illustrate the impact of well-structured ESOP programs:

1. Flipkart

Flipkart, India’s e-commerce giant, is often cited as the gold standard for ESOP success. When Walmart acquired Flipkart in 2018 for $16 billion, it wasn’t just the founders who reaped rewards— over 3,000 employees benefited from the company’s ESOP program.

Nearly 100 employees became crorepatis overnight, underscoring the immense wealth-generation potential of ESOPs. Flipkart’s decision to allocate generous stock options to employees early on proved instrumental in attracting top talent during its formative years. This approach also fostered a loyal workforce that remained committed through the company’s highs and lows. The Flipkart-Walmart deal set a precedent in India, demonstrating how ESOPs could transform employees’ financial futures and position startups as wealth creators.

2. Zerodha

Zerodha, India’s leading stockbroking platform, is another shining example of how startups can use ESOPs to create a culture of shared success. Unlike many startups that tie ESOP wealth to liquidity events like IPOs, Zerodha focused on enabling long-term wealth creation for its employees.

Through its "Rainmatter ESOPs" initiative, the founders emphasized the importance of employee ownership, distributing significant equity among team members. This move not only aligned employees’ interests with the company’s growth but also positioned Zerodha as a leader in employee-first practices.

3. Unacademy

Edtech unicorn Unacademy has consistently made headlines with its ESOP buyback programs, which allow employees to monetize their shares without waiting for an IPO or acquisition. In 2020, the company announced a ₹25–30 crore buyback plan, providing employees with immediate financial rewards for their contributions.

Unacademy’s approach to ESOPs reflects its commitment to empowering employees and recognizing their role in the company’s success. By offering regular buyback opportunities, the company ensures that employees can reap the benefits of ownership while fostering long-term loyalty.

4. Freshworks

When Freshworks, a SaaS giant founded in Chennai, went public on NASDAQ in 2021, it created an unprecedented wave of wealth for its employees. Over 500 employees in India held ESOPs, and many became millionaires overnight.

The Freshworks IPO was a landmark moment for the Indian startup ecosystem, showcasing the global potential of homegrown companies. By sharing the rewards of its success with employees, Freshworks demonstrated how ESOPs could serve as a powerful tool for fostering engagement and building a motivated workforce.

5. Swiggy

Swiggy, one of India’s largest food delivery platforms, has consistently rewarded its employees through generous ESOP buyback programs. In its 2024 IPO, the company’s buyback initiatives paid off immensely, with over 70 employees earning significant payouts under the ESOP scheme.

Swiggy’s approach to ESOPs reflects its belief in building a people-first culture. By regularly offering buybacks and ensuring employees benefit from the company’s growth, Swiggy has strengthened employee trust and morale. These efforts have also positioned Swiggy as a top employer in the fiercely competitive startup ecosystem.

6. OYO

OYO Rooms, despite facing significant challenges during the pandemic, has actively used its ESOP program to retain key talent and drive long-term growth. In 2021, the company expanded its ESOP pool and introduced liquidity options to enable employees to benefit from the company’s recovery and growth trajectory.

7. PolicyBazaar

When PolicyBazaar went public in 2021, it wasn’t just a milestone for the company—it was a financial windfall for its employees. The company’s ESOP program allowed numerous employees to benefit from the IPO, with many earning life-changing payouts.

PolicyBazaar’s success underscores the importance of equity-based incentives in the financial services sector.

8. Ola

Ola, India’s leading ride-hailing platform, has consistently used ESOPs to attract and retain top talent. The company’s decision to offer significant equity to employees has not only bolstered its workforce but also reinforced its position as a leader in the mobility sector.

In recent years, Ola has announced multiple buyback programs, allowing employees to cash in on their ESOPs and benefit from the company’s valuation growth.

9. Byju’s

Byju’s, the world’s most valuable edtech company, has leveraged ESOPs to attract top-tier talent in technology and education. The company’s expansive ESOP program has been a key driver of its ability to scale rapidly while maintaining a highly skilled workforce.

10. Urban Company

Urban Company, a platform connecting gig workers with customers, has adopted an innovative approach to ESOPs by extending equity ownership to service professionals as well as full-time employees. This inclusive model recognizes the critical role of gig workers in the company’s success and provides them with a tangible stake in its future.

Policy Recommendations

To unlock the full potential of ESOPs, policymakers and startups can take steps to address existing challenges:

1. Simplify Taxation

Align tax obligations with liquidity events to reduce financial strain on employees.

2. Encourage Buybacks

Startups should offer regular buybacks to provide liquidity options for employees.

3. Increase Awareness

Workshops and clear communication can help employees understand the value and mechanics of ESOPs.

4. Promote Employee-Friendly Policies

Governments can incentivize startups to expand ESOP pools, ensuring fair rewards for employees.

The Global Perspective

The global treatment of ESOPs varies significantly in terms of structuring and taxation, providing valuable lessons for India’s evolving framework. Here's an overview based on practices in various countries:

United States

The U.S. has one of the most mature ESOP ecosystems. Two common plans are Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs):

• ISOs are tax-advantaged, allowing employees to defer taxes until they sell the shares, with gains taxed as capital gains rather than income.

• NSOs, more common in startups, are taxed at the time of exercise and later upon the sale of shares. This dual taxation structure can be a drawback for employees.

The U.S. also provides significant tax incentives for employers, such as tax-deductible contributions to the ESOP trust, encouraging wider adoption.

Europe

Countries in Central and Eastern Europe are seeing growing ESOP adoption, but the legal and tax treatment varies:

• In Germany, gains from stock options are taxed as employment income at the time of exercise.

• In Poland and Hungary, employees benefit from reduced taxation if they hold the shares for a minimum period before selling.

United Kingdom

The UK offers tax-efficient schemes like the Enterprise Management Incentives (EMI), designed for smaller companies. Under EMI, employees enjoy tax relief if they hold the shares for at least one year, with gains taxed as capital gains, not income.

Southeast Asia

Southeast Asia’s ESOP landscape reflects its diversity:

• Singapore is particularly attractive, as it does not impose a capital gains tax, and stock options are taxed only if granted during Singapore-based employment.

• In Vietnam, taxation applies at the sale stage, easing immediate cash-flow challenges for employees. These nuances make ESOPs regionally adaptive, though navigating complex tax laws remains a challenge.

Conclusion

ESOPs are a powerful tool, bridging the gap between startups and their employees. They create a shared vision, aligning interests for mutual growth. While challenges remain, thoughtful structuring and supportive policies can ensure ESOPs fulfill their promise of transforming the Indian startup ecosystem.