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A complete founders’ guide to raising a successful angel round

Bonus: Get the list of 300+ top angels in the tech industry from around the world

If raising angel investment is a founder’s dream, the process of raising it is definitely their nightmare. 
In this guide, our CEO Ankit Pansari breaks down the steps that led to OSlash's pre-seed round.
Learn how to reach out to top angels and structure your round successfully.

OSlash Angel Funding Guide  Cover

Introduction

In November 2021, OSlash announced a $2.5 million pre-seed round led by Accel and covered by 50+ international publications. 

The round also saw participation from more than 45 angel investors - the who’s who of business and technology - including Dylan Field (Figma), Akshay Kothari (Notion), Girish Mathrubootham (Freshworks), Olivier Pomel (Datadog), Nicolas Dessaigne (Algolia), among others.

Fun fact: We had a few angels also investing as low as $1000 into the OSlash pre-seed round! 

How did we pull this off?

I put this guide together to answer exactly that question and to make the process of raising an angel round more transparent and easier to understand. I know what a struggle it can be to navigate obscure logistical and legal processes involved in fundraising. The lack of actionable resources for first-time founders only compounds the problem. This is a small attempt from me to solve it for you.

Unlike institutional investors such as Venture Capital (VCs), angels are individuals who take an interest in the startup at a very early stage, when the risks are still high and the fate of the startup is largely undecided. They can be the most crucial source of not just funding, but also provide an ecosystem of social and informational capital that helps a startup thrive. 

If you are an early-stage founder looking to leverage the strengths of angels for your venture, this guide can prove extremely useful to you. 

It comes with lessons from my personal, hands-on experience. Having conducted multiple private and group sessions for founders and VCs on how to structure a successful angel round prompted me to pen it all down for easy reference. 

Let’s dive in!

What is covered in this guide? 

Think of this guide as the ultimate playbook for raising money from angel investors. It will help you understand:

  1. Who are angel investors and how they can support your business 
  2. How to set goals and structure a successful angel round 
  3. How to reach out to angels
  4. What collaterals to prepare for your round
  5. How to close your round
  6. FAQs

What inspired this guide? 

Fundraising is a double-edged sword for a startup founder. 

On the one hand, it is everything you detest - tedious processes, heaps of paperwork, red tape, and bureaucracy. It eats up time you could be investing more fruitfully in building products, conducting market research, talking to your users, and scaling your business. 

On the other hand, it is indispensable if you want to grow. The angel investors you get on your cap table will not just provide finances, but also lend a helping hand as you build your business from the ground up. I wrote this guide to clear the many misconceptions founders have when they think about raising an angel round.

Who is this guide for?  

  1. This guide is for founders of technology companies, who are currently raising their seed round and would like to have angel investors participate or lead the round
  2. This guide will discuss in-depth how companies can raise a successful angel round from multiple angel investors
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Who are angels and how can they help? 

Ever wondered why they are called angels and not simply investors? It is because they bring in so much more than cash. They bring in kindness. They are ready to believe in your dream when few others do. And they are ready to put their money where their mouths are. They are your staunch supporters who want your business to succeed as much as you want it.  

And how can they help? Well, most angels are themselves successful entrepreneurs, business leaders, innovators, and visionaries who want to help make the world a better place and give back to the community that supported and mentored them in need. They do this by:

  1. Backing your idea with much-needed finance
  2. Capitalizing on their vast networks and introducing you to the right connections. These could be additional investors, technical or business mentors, and coaches, great candidates you could hire, or even early customers for your pilots
  3. Providing a wealth of industry-specific knowledge and know-how gathered and embellished from years of personal and/or second-hand experience, especially if you are building a venture in a very regulated or vertical business
  4. Cheerleading you and lending crucial moral support and encouragement when plans go awry and you need to do some rethinking, make some adjustments, and pivot

Different types of angel investors? 

There are different kinds of angel investors you can have on board, in order to maximize the utility and benefits you derive out of your angel round. They include:


1. Fellow founders: 

  • They are angels who have built their own companies, often from scratch, going through each stage of the complex process. They can guide you through every aspect of founding a business and can be mentors and coaches to you
  • Since they have faced similar challenges and navigated similar journeys, they are well-qualified to dispense relevant and actionable advice for your company. They can share the best playbook from their journey
  • The only thing to keep in mind is that if they are very successful founders, they will not be able to dedicate too much time and energy to your company
  • Ex - Dylan Field, CEO of Figma or Girish Mathrubootham, CEO of Freshworks. 


2. Super angels

  • Also called archangels, super angels are extremely active investors who have a huge network of executives and advisors
  • They have a knack for making money from their well-researched and often commercially successful investments in hundreds of companies
  • Ex - Naval Ravikant, Brianne Kimmel

3. Domain experts: 

  • Angels, who can double up as domain experts, can be a valuable resource for know-how when you are building a deep tech company or going after a vertical industry such as healthcare, insurance, or construction
  • There are some investors who have deep domain expertise in certain markets, such as NFX. The entire founding team is that of operators who have built and run marketplaces companies
  • Ex - Lenny Rachitsky, Balaji S.


4. Operator angels: 

  • They are senior executives in the business such as product, engineering, or marketing leaders. It can be VP Engineering at a big tech company or a Marketing Director at a consumer goods conglomerate
  • Ex - Shreyas Doshi, Cristina Cordova

How to structure your angel round?

For a successful angel round, I will break down the process of fundraising into four steps: 

  1. Goal: Planning how much money you want to raise and from whom 
  2. Outreach: Creating a lead pipeline and networking 
  3. Preparation: Creating collaterals such as an elevator pitch, investment memo, company deck, and product demo 
  4. Closure: Creating  a legal structure to collect cheques from multiple angel investors

1. Goal

How much to raise?

If you already have a lead investor and are planning to raise money from a number of small investors, I recommend keeping at least 10 to 15%  allocated to angel investors. While negotiating with your lead investor, please mention at the outset that at least 10 to 15 % would be allocated to angels. 

In OSlash, we kept a 20% allocation for angels, and our lead VC firm, Accel, was completely on board with the idea. They even introduced us to some angels. 

From whom to raise? 

Angel Investing can happen in two ways - where angels themselves are leading the round (also called Party Round) or you have a VC firm leading the round and angels participating in that round. If you already have a name VC firm leading you around, you would like to get a few angels to participate. 

  1. If you are working on a dev project, it will help to have founders of companies such as Vercel, Github or Stack Overflow on your cap table as they have already built an audience around developers
  2. If you are building a consumer tech company, try to get founders of companies such as Instagram, Bumble, Calm and others, who will be good for your cap table 

2. Outreach

i. At the outreach stage, you should create a long list of potential angels who could participate in your angel round. 

ii. Your list should have a combination of: 
- successful founders in your category
- leading operators who can help you build the engineering, product, or marketing functions
- super angels who can open more doors for future fundraising

iii. I recommend putting together a list of 100 to 150 angels. 

  • If you don’t know where to start, we have created a list of the most prolific angels, which we would love to send to you.
OSlash Angel Funding Guide  Cover
Get our list of top angels from around the world
Get the complete list of 300+ angels in the tech industry from around the world
Awesome!

Please check your inbox for the complete list
and other additional info
Request a demo
Oops! Something went wrong while submitting the form.

  • Send personalized emails to these angels and ask for warm introductions. Follow them on Twitter and if their DMs are open, don’t hesitate to send them your elevator pitch. 

3. Preparation

You have to lay the groundwork for your potential angels and present them with all the necessary information they need to make a sound investment decision. 

After all, an angel is an individual, not an institution. They will be investing their hard-earned money and their trust into your business for a high-risk high-return proposition. Raising money is an exercise in trust-building. 

Getting their support will be far easier if you do the following religiously, provide full disclosure in the investment documents, and cover all your bases properly.

You have to work on four major preparation collaterals:

i. Elevator or email pitch
ii. Investment memo
iii. Deck
iv. Product demo 

i. Elevator Pitch

Write a short blurb about the business. Introduce the company, the problem, and the value proposition or solution you propose with its potential benefits.  

Keep it concise (so much so that you can explain it in 30 seconds to one minute). 

Here is ours, for example: At OSlash, we are building an all-in-one enterprise URL manager that lets you name, structure, access, and organize long workplace links by converting them into human-readable shortcuts. This simplifies and speeds up information-sharing, productivity, and collaboration for you and your team.

ii. Investment Memo

Expand on the blurb by writing a comprehensive investment memo. 

This will be the main document that outlines the key components of the business and presents the case and rationale for investors to put their money into it. Express all the crucial information about the business but also keep it simple. 

Here is a draft template you can use: 

  1. Introduction: This should detail:
    a. What you do
    b. The problem you intend to solve
    c. The proposed solution
    d. The business model/how the solution will make you money 
    e. The scale of the opportunity
  2. Metrics: Highlight in numbers, charts, and graphs:
    a. The traction up to now (include a chart)
    b. Revenue drivers
    c. What go-to-market looks like
  3. Challenges to growth: Mention:
    a. The obstacles hindering you from growing faster
    b. How raising money can help overcome the problem
  4. Market: Define:
    a. Your target customers and ICP
    b. The thinking patterns and behavior of your ideal customer
    c. The scope of the opportunity your target market presents
  5. Competitive Landscape: Answer how you plan to take on and beat the competitors
  6. Team: Explain the unique strengths and opportunities your team brings with it
  7. Use of funds: Elaborate on how much you plan to raise, from whom, and what you plan to do with it


Try to explain the business and why the timing is right for the venture. It’s extremely important to draft a good business memo. The memo is your source of truth for all follow on investment materials that you are going to create in the company. 

Here are a couple of good investment memos which are public: 

  1. Rippling
  2. Airbase

iii. Deck

Create a full presentation based on your investment memo. 

Your deck is a visual and succinct representation of your memo. Keep the number of slides limited and focus only on meaningful data without being too detailed. 

Tailor your deck according to the audience; do a little research before you pitch and get to know the people you’ll be pitching to better. 

One of the best guides we have found online on how to pitch decks is by Reid Hoffman - LinkedIn Deck pitch to Greylock Partners

iv. Product Demo

  1. Remember raising funds is an exercise in trust-building. Since it is impractical to meet all the angels because of location and COVID norms, founders have to get more creative and go the digital way for fundraising.
  2. You can easily make a Loom video of the product or create an early self-sign version for your angels to try out. 
  3. At OSlash, we ended up doing both - we made a Loom video with the signup link for the product. You can find it here osl.sh/demo
  4. If you want to learn how to create a compelling product demo, here’s a Twitter thread I wrote on this. 

4. Closure 

We are now moving to the final stages of collecting the cheque and closing the round. 

This is where things usually get complicated. I have seen founders spending a lot of time here and experiencing frustration.

Perils of an angel round

Although having a lot of angels is extremely beneficial for your company, managing all of them is cumbersome:

  1. Your cap table will get very messy: Early-stage founders don’t realize how difficult it is to maintain a cap table. When you are starting out, you will have only a few line items such as a Lead-VC, founders, and employees. But, as you start adding angels and future investors, the number starts becoming larger. You will have to invest in Cap Table Management software such as Carta or Pulley.

  2. Legally expensive: If your lawyers need to create separate legal documents for every angel, your legal fees will end up going through the roof. In future rounds, your legal cost will rise further due to a messy cap table. Late-stage investors will be disappointed as more due diligence will be required.

  3. Chasing signatures and wire transfers: You will need signatures from each angel whenever you are raising a new round. Moreover, you will have to keep track of every wire that has reached your bank account and keep all your angels updated accordingly. 

Fortunately, there is an easy way out of all this. Our friends at AngelList have come up with a brilliant solution - the AngelList Roll-up Vehicle. 

AngelList Roll-up Vehicle 

  1. Roll-up Vehicles (RUV) are a special-purpose entity set up to create a single holding company for all your angels.  
  2. You can get all the investors to invest via a single entity - without bringing them individually into your Cap Table. 
  3. Upto 250 angels can invest via a single RUV. 
  4. As a founder, you get a neat dashboard where you can track all the investments and stages of wire transfers directly into the company. 
Funding Dashboard
  1. Your investors can directly transfer the money using the ACH payment mode and also save the cost of wire transactions. 
  2. It is as simple as sharing a link with all your investors. 
Funding Dashboard 2
  1. Once angels transfer the money to AngelList, the latter will take care of all legal formalities and wire the money to your company account, once the round is closed. 
  2. The best part? RUV is private. Only people with the invite links can invest in RUV. 

Conclusion

Now that you know how to raise a successful angel round for your startup, it may be worthwhile to point out that fundraising is often an ongoing battle and not a one-time affair.

As a founder, your goal should be to close the round as fast as possible so that you can go back to doing what you know and do best - building your company.

I hope that this guide can help you get one step closer to doing that with more awareness, simplicity, and ease of mind.

If you have any questions, you can always reach out to me at ankit@oslash.com and I’d be more than happy to help.

Happy fundraising!

FAQs

  1. When is the right time to raise money? How do I know when my business is eligible for an angel round?

    The right time to raise money is when you have discovered product market fit. Generally speaking, a business can survive in the long run only when there are people who will buy what it sells. So there should be demand for your product or service and people should be willing to pay for it.

    But even before that the question to ask is whether the business even needs angel money? Whenever we think of raising private money or raising money from investors, we have to keep in mind that the business must scale and provide an exit to existing investors. If you're thinking of building a large business, which you believe can scale and go public someday, and will make money for people who are investing in it, then it may be right to go for angel investment. When you know that the business is eligible, make sure you have some understanding of where the customers are going to come from. Because only then will the business succeed and scale, and make money for private investors. 

    In conclusion, the moment you reach some level of product market fit, you should look at raising some angel money.

  1. What does an angel investor look for while investing in a startup?

    I think there are three major things:

    a. Team - The first thing which any investor, angel or VC, looks for in the startup is the team. Is the team passionate about the problem? How do the founding members know each other? How long have they been working on this problem? 
    There are a lot of examples where the team has started with a product and has pivoted to something else, Twitter being one of the most famous ones. It started off as a messaging service before Jack Dorsey and team pivoted to Twitter. 

    b. Large market size - The second thing they look for is if the market is large enough. If it is, they know that there are going to be multiple companies, which will go after this market and someone is going to win. A good example is the food delivery business.
    People are going to order food. But this is particularly relevant when angels are investing in a technical product, which may not be exactly like a consumer product with a readymade market.

    c. A problem they can relate to - If you are trying to solve a problem that angels have themselves experienced or one that they relate to, it serves like validation for them to invest in the startup. 

  1. How do angel investors differ from a VC?

    There are four major differences between angel investors and VCs:

    a. Cheque size - Angels don't invest as much as VCs. While VCs can invest anything from $500,000 all the way to $500 million, the usual upper limit for angels is $100,000. And they can also invest as low as $1000.

    b. Structure - Angels are generally individuals (can also form angel groups to come together and invest). But VCs are structured as a firm.

    c. Source of the funds -  VCs raise money from large banks, pension funds, universities etc. to deploy into startups. Angels usually invest their own money. But, nowadays you also have angels who raise money to invest in companies.

    d. Engagement level - With a VC, because of the firm structure, you have different engagement levels. You have analysts, associates, and partners who would actually be on the board and engage with you. Unless a VC firm has said yes to an investment, a partner is not going to be involved in the business. But, an angel is investing alone. They are trying to help you. They are trying to work with you so they will be personally involved from day one.

  1. Should I negotiate with an angel? How do I best prepare for negotiations?

    a. In most cases, you won’t need to negotiate with an angel because angels are extremely founder-friendly. In fact, you should watch out for angels who try to back you into a corner and reconsider engaging with them. Most angels would try to accommodate whatever your needs are. In my experience, they want to make sure they do right by the founders.

    b. In some cases, however, you might have to negotiate, especially where they are asking for a larger allocation in the business that you can’t comply with. For example, you're raising a $2 million round out of which only $200,000 is reserved for angels. And you have an angel who wants a $50,000 allocation (that is 25% of your allocation) that you can't allow. You might have to ask them to reduce it to a $20,000 allocation. In such cases, you need to be very upfront with them and make sure that you give them some upside in the later rounds.

    c. In addition, there can be one peculiar situation where you may have to negotiate. Let's say if the valuation of the company is not defined and angels are coming together in the round, you can ask the lead angel to come up with a good valuation for the company, or come up with one yourself. And if they are negotiating, try to understand where they are coming from. Also keep in mind, angels are investing their own money. So you, too, don't want to be very greedy with the valuation.

  1. My collateral contains everything about my business. How do I protect the confidentiality of my idea?

    a. As I said before, angel fundraising is an exercise in trust-building and it works both ways. If an angel is already investing in your startup, they have a vested interest to make sure all your rights are protected.

    b. But in some cases you will come across situations where they may try to show the collateral to another company especially when they might have an investment in a competitor company. To avoid that, try to clarify these things right on the first call with the angel.

    c. You can create authentication protocols for accessing the information. At OSlash, we kept our collateral on Notion and shared access only when the angel requested it. Or you can use something like DocSend where your deck can be shared only via email access. But a lot of this depends on trust. You do want to make sure the detailed numbers don't go out, but for the memo and deck, try to make sure access is authenticated. Make it fail safe.

  1. How expensive is it to raise an angel round? What are the major costs and fees involved?

    a. It was expensive to raise an angel round back in the day. Say if you're trying to get 20-30 angels, you have to bring them all onto your cap table. There’s the legal cost of paperwork. You have to follow up with them to coordinate wire transfers - make sure they send the right banking information, collect the cheques, and more. For us, it was not just legally expensive but also cost a lot of time. 

    b. Thankfully, a few firms like AngelList came up with a special purpose vehicle where all of these angels can come together as one structured firm and the firm can invest as a single entity in the cap table. And that used to cost $8,000 - all that was required for a successful angel round.

    c. Now, with AngelList RUV, things have become even easier. Plus, if a company is incorporated in Delaware and you are raising SAFEs or equity, they offer a no-fee RUV. There is zero cost attached to it. Most software companies incorporated in the US are Delaware incorporated, but if you're not a Delaware incorporation, the whole thing can be done at $2,500 which is still a pretty good deal.
  2. What should I do if an angel refuses to invest in my startup? If a deal falls through?

    If an angel says no to investing in a startup, that's completely okay! You have many out there, you know? Try to speak with more angels. And I think that should also be a goal. You should always aim higher. Try to get more angels than you need, because some of them might change their mind. After all, all of us are human. So it's not a big deal.

FAQs

  1. When is the right time to raise money? How do I know when my business is eligible for an angel round?

    The right time to raise money is when you have discovered product market fit. Generally speaking, a business can survive in the long run only when there are people who will buy what it sells. So there should be demand for your product or service and people should be willing to pay for it.

    But even before that the question to ask is whether the business even needs angel money? Whenever we think of raising private money or raising money from investors, we have to keep in mind that the business must scale and provide an exit to existing investors. If you're thinking of building a large business, which you believe can scale and go public someday, and will make money for people who are investing in it, then it may be right to go for angel investment. When you know that the business is eligible, make sure you have some understanding of where the customers are going to come from. Because only then will the business succeed and scale, and make money for private investors. 

    In conclusion, the moment you reach some level of product market fit, you should look at raising some angel money.

  1. What does an angel investor look for while investing in a startup?

    I think there are three major things:

    a. Team - The first thing which any investor, angel or VC, looks for in the startup is the team. Is the team passionate about the problem? How do the founding members know each other? How long have they been working on this problem? 
    There are a lot of examples where the team has started with a product and has pivoted to something else, Twitter being one of the most famous ones. It started off as a messaging service before Jack Dorsey and team pivoted to Twitter. 

    b. Large market size - The second thing they look for is if the market is large enough. If it is, they know that there are going to be multiple companies, which will go after this market and someone is going to win. A good example is the food delivery business.
    People are going to order food. But this is particularly relevant when angels are investing in a technical product, which may not be exactly like a consumer product with a readymade market.

    c. A problem they can relate to - If you are trying to solve a problem that angels have themselves experienced or one that they relate to, it serves like validation for them to invest in the startup. 

  1. How do angel investors differ from a VC?

    There are four major differences between angel investors and VCs:

    a. Cheque size - Angels don't invest as much as VCs. While VCs can invest anything from $500,000 all the way to $500 million, the usual upper limit for angels is $100,000. And they can also invest as low as $1000.

    b. Structure - Angels are generally individuals (can also form angel groups to come together and invest). But VCs are structured as a firm.

    c. Source of the funds -  VCs raise money from large banks, pension funds, universities etc. to deploy into startups. Angels usually invest their own money. But, nowadays you also have angels who raise money to invest in companies.

    d. Engagement level - With a VC, because of the firm structure, you have different engagement levels. You have analysts, associates, and partners who would actually be on the board and engage with you. Unless a VC firm has said yes to an investment, a partner is not going to be involved in the business. But, an angel is investing alone. They are trying to help you. They are trying to work with you so they will be personally involved from day one.

  1. Should I negotiate with an angel? How do I best prepare for negotiations?

    a. In most cases, you won’t need to negotiate with an angel because angels are extremely founder-friendly. In fact, you should watch out for angels who try to back you into a corner and reconsider engaging with them. Most angels would try to accommodate whatever your needs are. In my experience, they want to make sure they do right by the founders.

    b. In some cases, however, you might have to negotiate, especially where they are asking for a larger allocation in the business that you can’t comply with. For example, you're raising a $2 million round out of which only $200,000 is reserved for angels. And you have an angel who wants a $50,000 allocation (that is 25% of your allocation) that you can't allow. You might have to ask them to reduce it to a $20,000 allocation. In such cases, you need to be very upfront with them and make sure that you give them some upside in the later rounds.

    c. In addition, there can be one peculiar situation where you may have to negotiate. Let's say if the valuation of the company is not defined and angels are coming together in the round, you can ask the lead angel to come up with a good valuation for the company, or come up with one yourself. And if they are negotiating, try to understand where they are coming from. Also keep in mind, angels are investing their own money. So you, too, don't want to be very greedy with the valuation.

  1. My collateral contains everything about my business. How do I protect the confidentiality of my idea?

    a. As I said before, angel fundraising is an exercise in trust-building and it works both ways. If an angel is already investing in your startup, they have a vested interest to make sure all your rights are protected.

    b. But in some cases you will come across situations where they may try to show the collateral to another company especially when they might have an investment in a competitor company. To avoid that, try to clarify these things right on the first call with the angel.

    c. You can create authentication protocols for accessing the information. At OSlash, we kept our collateral on Notion and shared access only when the angel requested it. Or you can use something like DocSend where your deck can be shared only via email access. But a lot of this depends on trust. You do want to make sure the detailed numbers don't go out, but for the memo and deck, try to make sure access is authenticated. Make it fail safe.

  1. How expensive is it to raise an angel round? What are the major costs and fees involved?

    a. It was expensive to raise an angel round back in the day. Say if you're trying to get 20-30 angels, you have to bring them all onto your cap table. There’s the legal cost of paperwork. You have to follow up with them to coordinate wire transfers - make sure they send the right banking information, collect the cheques, and more. For us, it was not just legally expensive but also cost a lot of time. 

    b. Thankfully, a few firms like AngelList came up with a special purpose vehicle where all of these angels can come together as one structured firm and the firm can invest as a single entity in the cap table. And that used to cost $8,000 - all that was required for a successful angel round.

    c. Now, with AngelList RUV, things have become even easier. Plus, if a company is incorporated in Delaware and you are raising SAFEs or equity, they offer a no-fee RUV. There is zero cost attached to it. Most software companies incorporated in the US are Delaware incorporated, but if you're not a Delaware incorporation, the whole thing can be done at $2,500 which is still a pretty good deal.
  2. What should I do if an angel refuses to invest in my startup? If a deal falls through?

    If an angel says no to investing in a startup, that's completely okay! You have many out there, you know? Try to speak with more angels. And I think that should also be a goal. You should always aim higher. Try to get more angels than you need, because some of them might change their mind. After all, all of us are human. So it's not a big deal.

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ESOPs simplified — A must-read guide for tech founders and employees

Bonus: Get the blueprint of the OSlash ESOP policy to effortlessly build one for your organization

ESOP Policy Cover

With companies adding stock options to compensation packages, it’s important for both founders and employees to understand how ESOPs work. This guide by our CEO, Ankit Pansari, will help dispel the ambiguity around equity compensation in early-stage tech companies.

Introduction

If you are an employee or a founder of a tech company, it’s imperative that you know about Employee Stock Option Plans (ESOPs). 

While setting up an ESOP policy for OSlash, we realized one thing. Though the term is prevalent in the industry, both tech founders and employees actually understand very little about ESOPs. This can cause a lot of confusion and misunderstanding about their rights and obligations with respect to ESOPs. 

To dispel the myths and bring transparency to how ESOPs work, we decided to pen this guide and share our learnings — sourced from founders of reputed tech companies such as Notion and Figma and also from our experience at OSlash.

1.1 What is this guide?

Think of this guide as the ultimate playbook for understanding Employee Stock Option Plans (ESOPs) — for both employees as well as founders

This guide covers

  1. An introduction to equity compensation in tech companies — its origin, how it is granted, and types of equity structures in companies
  2. Why equity compensation is important for modern tech companies
  3. Basics of ESOPs
  4. An understanding of ESOP valuation
  5. Employee view of ESOPs — taxation, when to sell, and things to look for
  6. Founder view of ESOPs — planning the ESOP pool, identifying the goals of equity compensation, and steps required to introduce an ESOP policy in the company
We’ve made our ESOP policy public to transform your confusion into clarity as you build one for your organization
Thanks, you’re all set!

Check your inbox for an email with the link to our ESOP policy.
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1.2 Who is this guide for?

  • For employees whose compensation involves ESOPs 
  • For founders looking to set up an ESOP policy for their startup from scratch
  • For founders looking for additional information to restructure their startup’s ESOP policy
  • For anyone who wants to understand ESOPs but is confused by the jargon-heavy explanations on the internet 

1.3 Why this guide?

  • ESOPs have become an increasingly common form of compensation across tech companies, especially startups 
  • People are motivated to join startups that have attractive ESOP plans. But, there is a lack of simple, understandable information about how ESOPs work, with 57% of employees citing they would like more educational guides and FAQs on the topic
  • There is absence of factually correct guidance for founders to set up their ESOP policy
  • Founders struggle to correctly and satisfactorily explain ESOPs to employees 

1.4 Disclaimer 

  • We are not lawyers. Please consult a lawyer before you adopt any of the recommendations we discuss in this document
  • This guide is specific to the US employee stock option plans for modern early-stage tech companies. Most of the specifics might not translate to other jurisdictions

2. Understanding equity compensation

Because ESOPs form an important part of employee compensation at modern tech companies, let’s first understand how compensation is structured typically at an early-stage tech startup. 

2.1 The structure of compensation in tech companies 

Types of Compensation

Compensation in tech companies is typically a combination of the following components

  • Salary: The monthly paycheck received by an employee
  • Bonus: A time or performance-based incentive granted to employees once a year or on achieving a set performance benchmark
  • Other benefits: These include perquisites (or perks) such as health insurance, expense reimbursements, retirement benefits, and other amenities such as certification courses, gadgets, gym memberships etc. 
  • Equity: Simply put, equity compensation is a stake in the ownership (and therefore the growth and profits) of the company. However, equity comes in various forms, and not all equity compensation grants employees the same rights and benefits in the company

2.2 What is equity? How is it different from equity compensation?

As mentioned, equity refers to shares in a company’s ownership. 

A company is a legal entity formed by a group of individuals to conduct a business. It has its own separate identity, distinct from the owners, such that the assets and liabilities of the company are not equal to the personal assets and liabilities of the owners.

Equity (and equity compensation) is affected by the ownership structure of a company.

There are two types of companies – private and public. Equity in a private company is restricted to its management, investors, founders, and employees. A public company, on the other hand, raises money by offering its shares to the general public via an IPO. Shares issued via an IPO are publicly traded in the stock markets and anyone can invest in them. By purchasing these shares, such shareholders get equity in the company.

In both these types, equity compensation simply means that employees are compensated by giving them a stake in the company. In other words, employees become shareholders in the company.

2.3 Equity compensation in tech companies — the history

The origin of equity compensation in tech companies (and the origin of Silicon Valley itself)  can be traced back to 1957 when theFairchild Semiconductor Corporation came into existence. 

Founded by five scientists and three engineers, it was backed with a funding of $1.38 million by Sherman Fairchild, the largest shareholder in IBM. Each of the eight founders got to own 100 shares each, with another 300 shares reserved for managerial hires. The remaining 225 shares were taken by the two investment advisors who structured the deal.

The deal came with a condition: The investor, Fairchild, would have an option to buy shares from the founders and other shareholders at $3 million collectively if things went well. Things did go well and as a result, Fairchild could purchase all the shares from the founding team who became millionaires — receiving a quarter-million dollars each upon sale of their stakes. 

2.4 Equity compensation in tech companies — the present

In his accredited 2017 book — America, Inc: The 400-Year History of American Capitalism — venture-backed entrepreneur, Bhu Srinivasan, notes about the Fairchild Corporation deal: “While the eight men made substantial windfalls, the investment structure lacked the unlimited upside element now intrinsic to the idea of the Silicon Valley start-up.”

To drive the point home, consider the compensation structure of Frank Slootman, the CEO of cloud computing giant, Snowflake Inc. Slootman led the company to what became the largest software IPO in history, raising $3.4 billion. Care to guess how much his ESOPs are worth?

Take a look:

His stock options: 13,921,409 shares with a strike price of $8.8, which equates to 5% of the company.

Snowflake’s share price (Mar 2022)= $200 (approx.) making the shares worth ~$3 bn, which is an upside of 2172%.

This, among other reasons, is why equity compensation is so attractive. 

2.4.1 How is equity granted in tech companies today?

There are broadly two ways equity can be granted:

  1. Stock options -  A stock option gives employees the right (but does not create an obligation) to purchase a fixed number of shares of the company’s stock at a discounted price at some time in the future. Hence, it’s called an option. It’s a contract that an employee signs with the company. 
  1. Stock grants - Stock grants are generally simpler to understand than stock options. Here, companies directly pay employees shares of stock as part of their compensation. It is not up to the employees to buy the shares. The shares are received simply as part of income on a periodic basis. They are more common among large, public companies. 
Insider tip:
At OSlash, we prefer options over direct award of equity because we don't want our employees to pay taxes on the day of their receipt. If we provide them $10,000 worth of equity in a year, for example, tax authorities will count them as income and employees will be taxed in the current financial year. But if we give stock options (remember it's a contract), they don't have to pay taxes till it is actually exercised.

Both stock options and stock grants themselves come in many forms, giving birth to the different types of equity structures prevalent in companies today.

2.4.2 Types of equity structures

  1. ISO - Incentive Stock Options

Incentive stock options (ISOs) allow employees to buy shares of the company stock at a discounted price and come with tax benefits. They are not taxed until the stock is sold. To earn a tax break, they need to be held for one year after exercising (buying the shares), and two years after they were granted. On sale, they are taxed at lower rates than the ordinary income tax rate. 

ISOs are only valid for US citizens.

  1. NSO - Non-Statutory Stock Options

As opposed to ISOs, non-statutory stock options (NSOs) are taxed at the ordinary income tax rate when exercised, irrespective of whether the shares are held or sold immediately after being bought. 

While ISOs can only be granted to US employees, NSOs can be granted to foreign employees consultants, advisors, or business partners. 

  1. RSU - Restricted Stock Units

Restricted Stock Units (RSUs) are a form of stock grants. They represent the company’s promise to give you the shares or an equivalent value in cash after you spend a stipulated time in the organization. 

While RSUs don't require employees to actually buy any shares, they are considered part of ordinary income and are taxed when they vest. This means employees at companies that haven’t gone public suffer a disadvantage — they may have to pay tax on shares that they cannot yet sell. Hence, RSUs are usually offered to senior executives in startups who can pay taxes on receiving the shares. 

  1. SAR - Stock Appreciation Rights

Stock appreciation rights (SARs) are a type of equity compensation different from both stock grants and stock options. They are linked to the company's stock price during a fixed period. So, employees make a profit when the stock price increases. Unlike ESOPs however, they do not have to buy any shares themselves. They are given the amount of price rise in stock or cash.

3. Why is equity compensation important for modern tech companies?

Equity is a powerful incentive for both employees and founders.

3.1 For employees

  • The potential upside of being able to share in the profits of the company is high as equity can appreciate manifold as the company grows (while cash compensation might not). This offers employees a stake in the success of the company.
  • The benefit comes from being able to purchase company shares at a nominal rate to sell them for a huge profit (best case scenario). There are several success stories where employees became millionaires together with founders of the companies. 

    A very notable example is Google when it went public. Its founders Sergey Brin and Larry Page became the richest persons in the world, even the stock-holder employees earned millions.

    In May 2018, over a hundred Flipkart employees turned dollar millionaires as the company was bought over by Walmart which purchased ESOPs worth $800 million.

    In September 2021, over 500 Freshworks employees in India — with 70 of them below the age of 30 — became millionaires when the company became the first Indian SaaS startup to list in the US. Today, 76% of employees own shares in Freshworks. 

    “It gives me a great sense of fulfillment today. This IPO has given me an opportunity to fulfill my responsibility to all the employees of Freshworks till date who have believed in us over the last ten years and contributed to Freshworks,” - Girish Mathrubootham 
  • ESOPs come with tax benefits too, which we discuss later.

3.2 For founders

  • The sense of ownership from ESOPs results in commitment and alignment with the overall company goals—if the company does well, the employees do well too. Hence, ESOPs can be used as a powerful motivator to boost productivity.
  • ESOPs help attract talent. A senior executive from Google would not join an early stage tech company if they don’t have the significant upside of increasing the value of their ownership. 
  • ESOPs are a wonderful tool to help retain key talent. 
    In 2016, Flipkart’s Chief People Officer, Nitin Seth shared with HT Mint: “It’s pretty fair to say that 35-40% of the organization is what we see as our critical talent to whom we’re offering stock of the company. The number has gone up significantly—in the past years, the number was 10-20%. This is the highest in the history of the organization in terms of the stock that we’ve offered.”
  • They free up cash resources that would have otherwise been used for hiring talent. These can be invested in company growth instead.
  • They also make compensation packages look more attractive especially if the company has a cash crunch

Now that we know how (and why) equity compensation works, let’s dive into everything founders and employees need to know about ESOPs.

4. Basics of ESOPs

Let’s assume you join a company which offers you ESOPs in addition to your salary and cash/non-cash benefits.

This is what it may look like:
You are offered 1000 shares of stock at $1 exercise price each with a 4-year vesting period and a 1-year cliff. 

This means you have the option to buy 1000 units of stock in the company at $1 provided you meet a few predefined terms and conditions, as below.

4.1 What is the exercise price?

The exercise price (also called strike price) is the price at which you can buy the shares in the future irrespective of their actual (or market) price at that time. Your shares in the company may have a value of $10 each in 2030. Even then, you will only pay $1 to buy a share.

Do you see why ESOPs are so lucrative?
 
At OSlash, employees are offered a share at a strike price as low as $0.08 per share.

4.2 How to exercise your option?

Exercising the options means buying the shares guaranteed to you. Your options are essentially shares that you own in the form of a share certificate. You can exercise your options as you attain the legal rights to them — which happens periodically rather than in one go.

Insider tip:
You want to exercise the stock when you have the opportunity to sell it for a higher price than you are buying it.


Example:
In the above scenario, assume the stock price rises to $100. You still would be able to exercise your 1000 options by paying $1 per share i.e. $1000. This way you get to hold stock worth $100,000 at current value (a $99,000 profit).

You will be able to exercise the option within a predefined time period. This is the exercise period or the exercise window. After the exercise period, your options will expire. 

The exercise window is usually:

  • Seven to ten years as long as the person is working for the company 
  • Three to six months from leaving the company in case of termination of employment 

At OSlash, employees can exercise the option up to eight years after leaving OSlash, provided they spend two years in the company. 

4.3 What is meant by vesting, vesting period, and vesting schedule? 

Vesting is the process of getting full legal rights to the shares. Rather than giving them all in one go when someone joins, companies treat ESOPs like compensation. They give it out in small chunks over time.  

Companies will usually not allow stock options or grants to vest to new hires immediately upon their joining. Instead, employees receive parts of their equity compensation over a set period of time known as a vesting schedule.

A four-year vesting schedule is a common practice across tech companies, including here at OSlash. We follow a four-year vesting schedule with a one-year cliff, followed by monthly vesting.

This means an employee at OSlash would receive their stock options as follows:

0% will vest in the first 12 months

25% will vest on completion of the twelfth month

The rest will vest every month

4.4 What is meant by the cliff?

Cliff is the minimum period of time before you qualify to receive the first part of your options. For the above example, the one-year cliff means that you need to be working with OSlash for at least one year before the first (one-fourth) chunk of your ESOPs vest. If you were to leave before the year, you would not receive any ESOPs.

Understandably, companies use ESOPs to increase employee retention rates and to motivate them to stay longer.

Insider tip:
Not all companies follow the same vesting schedule, however. 

Three notably famous cases in point? Lyft, Stripe, and Coinbase. All three giants have switched to a one-year vesting schedule. Their compensation packages have been changed so that employees’ entire stock awards vest in one year, instead of the traditional four years. 

The reasons for accelerated vesting? 

The market for high tech talent is intensely competitive. Companies are trying to make their compensation more lucrative. Moreover, faster vesting schedules often go hand-in-hand with smaller equity grants each year. They result in cost-savings for fast growing companies whose valuations are rapidly rising.

Coinbase justifies this decision as being more employee-centric. “We don’t want employees to feel locked in at Coinbase based on grants awarded 3 or 4 years prior. We want to earn our employees’ commitment every year and, likewise, expect them to earn their seat at Coinbase.

We are also eliminating the one-year cliff from our new hire grants. We expect new hires to add value on their first day, so it only makes sense for them to start vesting rewards for their contributions.”

5. Understanding ESOP valuation

The value of ESOPs depends mainly on

  • The stage of the startup or company
  • The valuation of the company, and
  • The option pool

5.1. Stage and valuation of the company

Any venture-funded company like OSlash goes through different stages of fundraising, which impacts ownerships in the company.

Stage and valuation

OSlash is currently in the Seed stage. To understand how the company's valuation is determined, we need to understand the different types of shares in OSlash.

5.2 Different types of shares

There are two types of shares in OSlash — common shares and preferred shares.

  1. Preferred shares are given to investors, advisors, and angels. Since they provide us with money and advice, they have some 'preference' before all of us
  2. Common shares are the shares the management and employees of the company receive

Preferred shares are more expensive than common shares as they are entitled 

  • to receive dividends before common stock dividends can be issues
  • to be paid from company assets before common stockholders in case of the company’s bankruptcy

The cost of preferred shares determines the valuation of the company.

Remember that when we talk about ESOPs, we are referring to common equity shares.

Because of the above differences, the strike price of ESOPs cannot be the same as the price of preferred stock.

Insider tip:
The option’s exercise price is usually at a 70 to 80% discount to the preferred share price established in the prior round of fundraising. As an example, if we sold preferred stock at $1, the exercise price for the common stock value at that time would be somewhere between 20 and 30 cents per share.

Moreover, the lower the strike price for common shares, the higher the number of shares that can be issued as ESOPs. 


Getting to the exercise price is a challenging task. We need valuation consultants to come up with the right price. Companies like OSlash need to produce a valuation report called the 409a report.

We engaged a valuation consultant to come up with the report. The valuation is suitable for a whole year or until we raise more money.

According to the 409a report, the exercise price of OSlash common share is $0.08, whereas the price of a preferred share is $0.8. Preferred Shares are ten times more expensive than common shares.

As a result, OSlash employees get a discount of 90% as part of the ESOPs.

5.3 Option pool and dilution

The option pool (also called equity pool or ESOP pool) is a block of company shares that employers create, add to the existing number of shares, and set aside for future employees.

For example, if a company currently has 100,000 shares (100% of the company) and we create an option pool of 11,500 shares, there are now 1,11,500 shares of company stock on a fully diluted basis.

Note:
Fully diluted shares are the total number of common shares of a company that will be outstanding and available to trade on the open market after all possible sources of conversion, such as convertible bonds and employee stock options, are exercised.
(Source - Investopedia)

The ESOP pool is created by founders who dilute a certain percentage of their ownership to allocate to the pool (when the company is in its early-stage). If the ESOP pool is exhausted while there are still unmet hiring needs, further dilution may be done by founders (or even investors) to replenish the pool.

As a result, an ESOP pool affects existing ownerships in the company, impacts the share price, and thus the effective valuation of the company. 

Example:
When OSlash raises money from investors, we create new shares to sell to those investors. Now, the existing shareholders (say management, employees, early-stage investors etc.) will own the same number of shares as before. But, there will be a greater number of total OSlash shares available so that they will now own a smaller percentage of the company. This is what dilution is.

From the above example, if owners held 10,000 out of 100,000 shares earlier i.e. 10% of the company, after creating the pool, they will hold 10,000/111,500 shares now or 8.97% of the company.

In an ideal scenario, as the company acquires new funding, grows, and scales, its valuation keeps increasing. As a result, the value of each share held by each employee/owner/investor also rises. This means that despite dilution, they end up getting more (and not less) in each successive round of valuation — a small share but one of a larger pie.

Insider tip:
A larger option pool is attractive for hiring new employees and investors. But as we have seen, the bigger the option pool gets, the more diluted the ownerships become. The key is to set the right balance, keeping your fundraising and hiring needs in mind.

6. Employees' guide to ESOPs

6.1 When to sell your shares

After the vesting period is over, the employee can usually exercise the ESOPs and sell the shares. Of course, it makes sense to sell the shares when the option is in the money i.e. the strike price (purchase price) is lower than the market price. 

There are generally three occasions when an ESOP sale (also called Exit) is possible. You can sell your ESOPs

  1. In a buyback during the next round of fundraising - It is a common practice for companies to buyback ESOPs from existing (and even former employees) during fresh rounds of fundraising. A new set of investors come in and take the ESOPs of employees and infuse capital in the company
  2. When the company gets acquired (M&A) - The acquiring entity offers to buy existing ESOPs from the employees in order to complete the acquisition
  3. When the company goes public (IPO) - Usually, shares of an unlisted company are illiquid as the above two instances are fairly uncommon. When a company offers ESOPs, the expectation is that the employees who show greater commitment and continue with the company would eventually reap the benefits, potentially upon a future IPO, when the shares can be sold to the general public
  4. Secondary sales - This is more likely than an IPO in case of startup ESOPs. Employees can sell their shares after exercising their options to other shareholders such as existing (or new) investors

Private companies can also stipulate a lock-in period to make sure that employees do not sell the shares in the open market, as soon as they get them.

Since stock options have a shelf life (exercise window), if the company doesn’t go public, obtains the next round of funding, or gets acquired, within that time frame, your purchased options will expire. 

ESOP Lifecycle

6.2 Things to look out for

As you can tell by now, there are various clauses in an ESOP. 

Before agreeing to receive ESOPs, understanding what you are signing up for is important. 

  1. The worth of your ESOPs - Don’t be blindsided by the higher number of shares on offer. It does not mean you get more equity. The worth of your shares depends on the percentage stake you own in the total number of shares of the company’s stock. To figure this out, ask your employer for the number of “fully diluted” shares, which includes stock that has not been issued yet, but could be issued in the future. You can then use the valuation of the company to get an idea of the worth of your equity compensation. (Refer the section on option pool for more clarity)

  1. Risk - ESOPs, especially at early stage companies, carry risk. More startups fail than succeed. So, it’s a gamble — in the worst case scenario, your ESOPs may be worth nothing. This is important especially where employers may offer you more ESOPs if you take a salary cut. In the best case, your company may be acquired or listed and you may reap huge benefits.

    Just like Sudharshan (Susa) Karthik, Ex-Senior Product Manager at Freshworks. “When Freshworks went public last year (2021), the upside on my ESOPs was something beyond my wildest dreams,” he says. “But it is important that young folks realize that ESOPs are not a get-rich-quick scheme by any measure. I see a lot of people joining startups hoping to cash in millions on their ESOPs, which is an extremely rare event. It’s far more rewarding to look at ESOPs as the best way to tie your inputs to outcomes in a company and as a career-building exercise.”

  1. Vesting schedule - As a rule of thumb, the shorter the vesting period, the more quickly you receive the options, and the more quickly you can exercise them. Prefer shorter vesting schedules and cliffs and be wary of vesting schedules that have disproportionately higher vesting in later years, as they can act like “golden handcuffs”, making leaving the company disadvantageous for you. Longer vesting schedules can also make you miss out on opportunities for exits.

  1. Liquidity and exit options - For listed companies, pricing is an issue, as their stock prices do not move in sync with performance. For unlisted companies, the problem is lack of liquidity and clarity on valuation. That is why companies must mention all exit options clearly at the time of grant. For instance, if the initial public offer is the only exit route, it must be stated clearly and the potential uncertainties related to listing brought to the employees attention.
    Source: Business Today

  1. Negotiation - Just like your cash salary, you should negotiate your ESOPs when you first sign a job offer. Think of ESOPs as any other investment opportunity. You want to maximize your gains while capping potential losses. When deciding how much stock to hold, assess your life-stage, finances, and risk appetite. Negotiate accordingly. 

    Like with other assets, diversification is also important for ESOPs. Don’t bank too much on ESOPs to make you extraordinary returns,” cautions Karthik. 
Insider tip:
Don’t hesitate to ask questions from your employer about your ESOPs. Most employers will answer them happily. 

6.3 Taxation

The tax treatment of ESOPs will depend upon the country of incorporation of the company as well as the nationality of the employees.

6.3.1 ESOPs given by foreign (say US) entities to Indian employees 

The tax treatment for ESOPs given by foreign entities (such as a startup incorporated in the US) to Indian employees is as follows:

  1. Upon exercise of ESOPs: The difference between the fair market value (FMV) of shares allotted and the discounted price (strike price) paid by an employee would be taxed as perquisite in the hands of the resident employee. The tax rate would be the ordinary income tax slab rate.
  1. Upon sale of shares acquired: At the time of sale of shares, the profits will be taxed as capital gains. Short-term gains (where shares are held for less than 24 months) are taxed at income tax slab rates, while long-term gains are taxed at 20%  with indexation benefits

The company has to deduct TDS from the salary of the employees in the month in which allotment/transfer of shares is made.

Note:
In 2020, the Indian Government announced that payment of income tax on startup ESOPs can be deferred from the time of exercise of ESOPs. Now, the tax liability arises within 14 days from any of the following events, whichever is the earliest:

  • after the expiry of 48 months from the end of the relevant assessment year; or
  • from the date of the sale of ESOP shares; or
  • from the date the employee ceases to be an employee of the startup that allotted the ESOPs 

Liability for deducting tax at source (TDS) on the startup also stands deferred.

*These benefits are available only for eligible startups. 

6.3.2 ESOPs given by US entities to US employees

The tax treatment here will depend on the type of ESOPs, namely ISOs or NSOs.

  1. NSO
    NSOs are taxed twice

    a. Upon exercise of the option: The spread between the fair market value (FMV) and the exercise price (also called strike price) is taxed at ordinary income tax rates. Employees are also charged employment taxes.

    b. Upon sale of shares acquired: To qualify for long-term capital gains treatment on the sale of stock purchased through an NSO, the shares must
    - have been held for at least one year after purchase
    - come from options granted at least two years prior to the sale

Stocks held less than one year after purchase or less than two years after grant date are subject to (higher) ordinary income tax treatment.

  1. ISO
    One of the qualifications for avoiding taxation on exercise of an ISO is that it must be equal to the FMV at the date of the grant. Employees must pay AMT (Alternative Minimum Tax) on the amount the FMV exceeds the option price at the time of the grant.

    This is unlikely, but could occur in a scenario where they were granted at a certain price by the company and a new 409a valuation was completed between their grant/purchase and exercise.

    ISO stock is taxable at the long-term capital gains rate when the same conditions specified for NSO above are fulfilled. In the case that early exercise is allowed, ISOs are eligible for the 83 (b) election, which allows one to avoid their taxation as income and also starts the clock on their consideration as capital gains.

    You must file the 83 (b) election within 30 days! There are NO exceptions.

7. Founders' guide to ESOPs

7.1 How to plan for an ESOP pool in every stage of funding 

As stated, to offer ESOPs, founders have to dilute a part of their own equity and create an ESOP pool. Employees are granted ESOPs from this pool. Further dilution may be necessary to replenish the pool in successive fundraising rounds. 

Thus, the ESOP pool size is inversely proportional to the company’s growth stage – as the company scales, the size of the ESOP pool decreases. 

7.1.1 Early Stage: ESOPs as compensation

Early-stage employees should get a higher reward (in terms of a higher share of ESOPs). They are taking higher risk by joining an unproven business venture and must be compensated adequately via ESOPs. Moreover, an early-stage company is quite illiquid. Attracting key executives in the absence of huge cash compensation is a problem that can be solved by giving more ESOPs as part of compensation.

7.1.2 Growth Stage: ESOPs as rewards

In the growth stage, the focus is on retention of key talent which drives growth. As the size of the ESOP pool reduces, it becomes prudent to reserve ESOPs for key personnel and award performance-based ESOPs. Moreover, as the company matures, and cash flows begin to improve, it is easier to award higher cash compensation to new employees who join than it is to dilute equity further. 

Insider tip:
It is considered a best practice to award ESOPs to all employees in an early-stage startup, irrespective of their role and seniority. This kindles the ownership among all and gives impetus towards company’s growth.

7.2 Goals when structuring equity incentive schemes

The goal of the policy should first and foremost be to set your team up for success

7.2.1 Allow early team members to have an equity setup similar to founders

At OSlash, we have tried to ensure that we all get equitable treatment in the hiring process with respect to equity compensation. 

Founders such as Girish Mathrubootham (Freshworks) instituted RSUs for every employee as they grew, a practice lauded by Karthik, who believes this is the best way to do right by the employees. 

The very first employee at Flipkart, Ambur Iyyappa, also received shares in the company which fetched him millions upon sale. 

7.2.2 Reduce the chance of team members owing equity-related taxes 

It is advantageous to offer stock options over direct equity. For example, $10000 worth of direct equity will be counted as income and will be taxed in the current financial year at ordinary income tax rates. But, since an option is a contract to buy shares, employees don't have to pay taxes till they exercise it.

7.2.3 Reduce the chance of team members losing equity for some technicality

Good employers will always try to draft an ESOP policy that makes sure their employees come out winning. This can take many forms including front-loaded or accelerated vesting (where the majority of shares vest within a short period of joining), no cliff period, monthly vesting after cliff instead of quarterly vesting, longer exercise periods for employees leaving the organization, and lower strike prices so employees can comfortably shell out the money required to buy the shares etc.

ESOP Graphics
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Here’s OSlash’s ESOP policy to help you navigate through all ambiguities 
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7.3 Summary of steps required to introduce an ESOP policy at your company

  1. Get the ESOP policy scheme draft prepared by your lawyer. You’ll have to figure out:
  • How many ESOPs to award whom (illustration below)
  • The strike price at which you will offer the options
  • The vesting schedule and cliff (if any)
  • The exercise period and conditions applicable on termination of employment/death/disability etc.
  • Whether the ESOP will be administered directly by the company via its Board or with the help of an ESOP trust
  • An exit price estimation
Determining ESOPS
  1. Communicate the policy to employees as clearly as possible and make the policy easily accessible to everyone.
Insider Tip:
Use OSlash to create a shortcut to your ESOP policy such that o/esop-policy can be accessed company-wide by everyone, every time.
  1. You can conduct a company-wide session to explain how ESOPs work in detail and to answer any questions your employees may have
  2. Register your ESOP policy and give grant letters to the employees

7.4 Actionable insights

Lastly, here are some actionable insights you may want to keep in mind before rolling out ESOPs at your startup:

  1. The earlier you create your equity pool, the better it is. The best employers reserve 12-15% of ownership for the equity pool. Remember, it’s not just a best practice but also a humane practice to be generous when it comes to ESOPs
  2. Your ESOP offering should change as the stage and valuation of your startup changes. Be flexible with ESOPs as your company grows and the balance between cash salaries and equity awards changes
  3. Since the ultimate goal of ESOPs is to encourage employee ownership and alignment with the company, focus on creating value for your employees and provide them fair terms

To conclude, we’d encourage founders to look at ESOPs through the lens of an employee. Or as Sudharshan Karthik says, “Use ESOPs to make the pie larger for everyone rather than have them act as golden handcuffs.”

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With companies adding stock options to the overall compensation package of their employees, it’s important to create a sound ESOP policy that gets all your legal ducks in a row. 

We’ve made our ESOP policy public to build transparency and foster an open culture of knowledge-sharing across organizations. 

Transform confusion into clarity as you build one for your organization. 

ESOP Policy

Download the policy to understand: 

  • How startups create a legally binding ESOP policy
  • Why should you create an equity incentive plan
  • The basics of equity compensation
  • How to generate your own stock option plan easily  to issue equity directly to your employees and shareholders, and automatically vest their shares in real time as your company grows