Esops don’t guarantee a windfall

If a large part of your salary is in stock options, it may not be the best structure

The Flipkart story is expected to have a fairytale ending for many of its employees. Reports suggest that Walmart has set aside nearly $500 million to buy back the employee stock options (Esops). However, the story, more often than not, is entirely different for many other start-ups. Many times, the founders and investors make money, but employees don’t get the same value for their stock options.

Recently, former employees of a Mumbai-based startup sued it alleging that they had been wrongfully deprived of gains on their stock options when a foreign company acquired it. When RedBus was acquired, many employees reportedly were unhappy as the deal didn’t trigger immediate vesting of stocks.

This may run contrary to the popular belief that Esops are a wealth creation tool, but there have been many cases where employees have ended up being disappointed, even felt betrayed. “Where ESOPs form an important portion of the employee’s compensation, the employee must take care to understand how the ESOP policy operates, including the vesting schedule and other terms. For instance, when a startup undergoes an acquisition the manner in which the ESOPs will be dealt with will depend on the deal structure and will have to be understood by the employees accordingly,” says Archana Tewary, partner, J Sagar Associates. There could be other reasons for employees not getting an immediate compensation for the Esops they hold. The acquiring company may sometimes offer its own shares by swapping the existing Esop programme. Then there are instances where the acquirer may want to

retain the current employees and may hence defer the vesting of Esops, or allow only partial vesting.

When joining a start-up, therefore, it’s essential that employees go through the terms and conditions of the programme, and read the clauses therein before signing the agreement.

“Many employees get a shock or feel betrayed when they either leave a start-up or when it is acquired. It’s only in such events they realise that Esops come with riders,” says Mohini Varshneya, head-ESOP services, Corporate Professionals.

Due to limited funds, start-ups usually hire employees at a salary lower than the levels prevalent in the market. To compensate for the lower pay, employees are offered Esops, which hold the promise of a windfall when the company starts doing well and is either acquired or comes up with an initial public offer. “While Esops have become more common, employees have to wait for a long time to get an exit,” says Varshneya.

Before joining a start-up, read the exit clause it offers. Understand what will happen to your Esops when you quit the company or if the employer terminates your services. If the norms include ‘conditional’ acceleration or acceleration clause that allows for alternatives, it would mean that the exit would depend on the acquirer or investors putting in money.

Unlike the US, where employee rights are protected by law, Esop regulations in India are not as stringent. Regulations do talk about the rights of employees but there are no stringent punishments or penalties if a company refuses to adhere to them. You will need to file a case in a civil court.