How to Set Up Your ESOP Pool as an Indian Company

According to Saison Capital’s report, The State Of ESOPs In India – 2021, which surveyed 268 Indian startups, a surprising 238 of them were unaware of ESOPs and their benefits. This knowledge gap is one of the key barriers to the widespread adoption of ESOPs in India.

At EquityList, we recognize the importance of addressing this roadblock. As part of our commitment to equity management, we’ve launched an ESOP 101 series to break down various equity-related incentive plans, making them more accessible and beneficial to both companies and employees.

What is an ESOP pool?

An ESOP pool is a portion of a company’s equity set aside specifically for issuing stock options to employees. It represents the number of shares allocated for the Employee Stock Option Plan (ESOP), typically making up a small percentage of the company's total equity. 

The creation of the ESOP pool requires the board’s approval and serves as a powerful tool for talent retention and motivation, with shares being granted over time as part of the employees' compensation.

What is equity compensation?

Equity compensation is a broad term for non-cash incentives that give employees a stake in the company’s success by offering partial ownership. 

The most common forms of equity compensation include Employee Stock Option Plans (ESOPs), Restricted Stock Units (RSUs), and Stock Appreciation Rights (SARs). 

Each of these tools helps align employee interests with the company’s long-term growth.

How to create an ESOP pool

Setting up an ESOP pool requires careful planning to ensure equity is allocated effectively across various roles, balancing the needs of early employees while retaining enough equity for future hires. 

Below are benchmarks suggested by Antler, which offer a structured approach to equity distribution at different stages:

1. Co-founders

a. Solo founder : Retains 100% equity until the first raise.

b. Multiple founders : Equity is either split equally or divided according to a pre-agreed arrangement reflecting contributions.

A 50/50 equity split between co-founders may seem like a fair approach, but it’s not always the best. Another Antler data shows that startups with equal equity splits among founders are 3x more likely to face internal dissatisfaction, yet it remains the most common practice.

An equal split doesn’t always reflect the unique contributions of each founder. Founders bring different levels of expertise, networks, and commitment, so assigning equity based on individual input leads to a more accurate and fair distribution.

To solve this, ‘CEO premium’ should be considered.

It refers to the idea that, as the person responsible for guiding the company's vision and leading the team, the CEO's role in driving long-term success often justifies a higher equity share.

For instance, in our equity management guide we mentioned how in Uber, Garrett Camp owned 4.6% at the time of the IPO, while Travis Kalanick, the CEO, held 6.7%, showing how the CEO’s role can warrant a greater stake.

c. New founders

Joining late (6+ months after founding) : Typically granted 20-40% equity, depending on their role and impact.

Joining Very Late (sub-20% equity) : If a potential co-founder is being offered less than 20%, reconsider whether this person should have co-founder status.

2. CXO roles

a. Pre-seed stage : Recommended allocation is 1-3% equity, depending on the criticality of the position.

b. Seed stage : As the company matures, this range narrows to 1-2%.

3. Directors/VPs

Pre-seed and seed stages : Receive 0.3-1% equity, depending on the strategic importance of the role.

4. Founding team members/Individual Contributors (ICs)

a. Mid-senior roles : Allocated 0.2-0.7% equity, ensuring that key talent is adequately incentivized.

b. Junior roles : Typically receive less than 0.2%, which still offers upside while preserving the ESOP pool for more experienced hires.

These benchmarks from Antler offer a practical framework for startups to structure their ESOP pools. 

However, it's crucial to remain flexible—while these guidelines provide a strong foundation, the specific needs of your company, the industry, and the seniority of the hires may warrant adjustments. Tailoring equity packages to reflect the unique contributions of each individual will ensure both fairness and long-term retention.

One should also be mindful of the fact that ESOP pools generally get larger as a company scales.

In the US, ESOP pools generally start around 10% at the seed stage and expand to 15% by Series A, with further increases in later funding rounds. By the time a company reaches Series D, the pool can grow to 20% or even 25%, according to observations by Index Ventures.

Steps to set up an ESOP plan

A private limited company needs to set up its ESOPs in India, complying with the Companies Act, 2013 and rules made thereon. 

Keeping this in mind, here’s how you can get an ESOP issue started:

1. Draft an ESOP scheme document

2. Alter the company’s Article of Association (AOA), if AOA is silent on the issue of shares to employees under the ESOP scheme

3. Alter the company’s Memorandum of Association (MOA), if the MOA does not have adequate authorized share capital

4. Convene a Board Meeting of the company for the following actions:

- approve the ESOP scheme

- approve the altered AOA and MOA subject to approval by members in the Extraordinary General Meeting (EGM), if required.

- approve the draft notice of the EGM

- authorize any person to send the notice of the Extraordinary General Meeting to all the members of the company (Get our expert advice here)

5. Dispatch of Notice of EGM to its Board members at least 21 days before the date of the EGM

6. Hold the EGM:

- for issuing of employees' stock option scheme by the shareholders of the company by passing an ordinary resolution for Private Companies and a special resolution for public companies

- for approving the altered MOA and AOA by the shareholders of the company by passing a special resolution

7. File an e–form MGT-14 to submit the special resolution within 30 days of passing the resolution

At the time of issuing any new grant, the company needs to hold a general meeting and seek approval of shareholders to grant options:

- to employees of a subsidiary or holding company; or

- to identified employees, during any one year, equal to or exceeding one percent of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of the option

Note: You can also set an ‘authorized’ person, also referred to as ‘authority’, chosen by the company’s board to implement, administer, and monitor the ESOP scheme and approve new grants offered to employees.

At this time, the company should have the valuation report from the Registered Valuer to determine the Fair Market Value. The details of any grants to employees, directors, or officers of the company are maintained in the ‘Register of Employee Stock Options’ in Form No. SH-6.

To wrap up, creating an ESOP pool is a powerful strategy that fosters employee engagement and retention while aligning their interests with the company's success. As the equity landscape evolves, it’s essential for organizations to understand and leverage ESOPs effectively.

At EquityList, we’re dedicated to demystifying equity management by equipping startups with the knowledge they need to implement impactful incentive plans.

Do reach out to us if you have any questions.