Employee Stock Option Plan (ESOP) for Early-Stage Startups

In early-stage startups, where cash is limited, Employee Stock Option Plans (ESOPs) offer a way to bring employees into the ownership journey. Done right, they align incentives, extend your runway, and help you build a team that’s in it for the long haul.

What is an Employee Stock Option Plan (ESOP)?

An Employee Stock Option Plan (ESOP) is a benefit plan that gives employees the right to purchase shares of their company at a fixed, predetermined price. 

These options typically follow a four-year vesting schedule with a one-year cliff. This means employees earn the right to exercise (buy) a portion of their options gradually, often starting only after completing the first year (cliff).

Unlike cash bonuses or salaries, stock options are directly tied to the company’s performance. If the company grows and its valuation increases, the value of the stock options rises too.

Why do early-stage startups consider an Employee Stock Option Plan (ESOP)?

77% of employees consider equity compensation to be an essential or very important part of their overall benefits package, according to a survey by Charles Schwab.

1. Hire experts without breaking the bank

Startups often operate with tight budgets, making it difficult to compete with the salaries offered by larger companies. 

Equity helps bridge that gap. 

Especially for senior or specialist hires, the opportunity to own part of the company can outweigh a slightly higher paycheck elsewhere. 

2. Build long-term commitment

ESOPs are typically structured with a vesting schedule, often including a one-year cliff, to ensure that equity is earned over time.

This structure serves two purposes: it rewards those who stay and contribute meaningfully, and it protects the company from giving away equity to short-term hires. 

3. Foster an ownership mentality 

When employees are also shareholders, their mindset shifts. 

Decisions are made with a broader lens, teams start thinking not just about their roles, but about what’s best for the company. This can lead to smarter trade-offs, deeper accountability, and stronger collaboration. 

4. Signal maturity to investors 

From an investor’s perspective, a well-structured ESOP pool signals maturity and foresight. Most VCs expect stock options to be part of your cap table, especially before or during a funding round. It shows that the founders are thinking about long-term team building. Equity incentives are also seen as a way to de-risk execution, ensuring the people behind the product are motivated to stick around and grow the company. 

How to set up an Employee Stock Option Plan (ESOP)?

Setting up an employee stock option plan (ESOP) is a strategic decision that impacts hiring, culture, and future fundraising.

1. Define your goals

Before you start drafting documents or calculating pool size, get clear on what you're solving for.

• Are you trying to attract experienced hires with competitive equity?
• Are you offsetting below-market salaries?
• Are you building long-term commitment and ownership?

Your answers will shape how you design and communicate your ESOP.

Example: Let’s say your startup is pre-seed, and you're hiring a founding engineer but can’t match market salary.

In this case, you might offer a larger-than-average grant (e.g. 1–2%) with acceleration on change of control. This means if the company gets acquired, some or all of their unvested options vest early.

Contrast that with a later-stage startup focused on retention. Here, grants might be smaller (e.g. 0.1–0.25%) with standard 4-year vesting and no acceleration.

2. Decide the ESOP pool size

Most early-stage startups allocate between 10% and 20% of their total equity to an ESOP pool. The right size depends on:

• anticipated hiring needs
• equity norms in your geography or industry
• investor expectations at your current or next fundraising stage

💡Pro tip: Investors often ask founders to expand the ESOP pool before their investment closes, so the dilution impacts existing shareholders only. Plan for this in your negotiations.

3. Structure the plan thoughtfully

Some important things to consider when drafting the plan are:

a. Eligibility

Eligibility for ESOPs depends on both company policies and local laws. 

For example, in India, only employees and directors (excluding independent directors) can receive ESOPs. Advisors and contractors are excluded and may need alternative equity instruments like phantom stock or SARs.

In the U.S., employees are typically granted Incentive Stock Options (ISOs), while advisors and contractors receive Non-qualified Stock Options (NSOs) - both are different types of stock options.

Employers may also set additional conditions, such as minimum length of service, performance benchmarks, or achievement of certain goals. 

b. Vesting schedule‍

The standard vesting schedule is 4 years with a 1-year cliff, but you can adjust based on hiring needs or exit timelines.

c. Exercise price‍

Usually set at the fair market value (FMV) on the grant date or lower.

d. Exercise window‍

Decide how long employees have to exercise their options after leaving. It ranges from 90 days to several years.

4. Draft the ESOP scheme and get approvals

This is the legal foundation of your plan. It should clearly define:

• who qualifies for grants
• how vesting works
• what happens in case of exit, termination, or change of control
• tax and compliance obligations

You’ll need to:

• work with legal counsel to draft the ESOP scheme
• get it approved by your board (and often shareholders)
• amend your Articles of Association or equivalent governing documents

5. Issue grants

Once the scheme is approved, you can start issuing stock options. Each grant should be documented with:

• the number of options
• vesting terms
• exercise price
• provisions for termination, exit, and change of control

Avoid one-size-fits-all allocations. Tailor grants based on role, seniority, and expected contribution.

6. Educate your team

Stock options are not always intuitive. Take the time to explain:

• what equity means
• how vesting works
• how to calculate potential upside
• what risks and trade-offs are involved

Create internal FAQs, host equity education sessions, and make sure employees understand the value behind their options.

7. Stay organized with equity management tools like EquityLIst

A messy cap table can derail fundraising or exits. Use equity management software to:

• track grants and vesting schedules
• generate and store grant agreements
• stay compliant with filings and disclosures
• run due diligence faster 

When to introduce an Employee Stock Option Plan (ESOP)?

There’s no perfect time to launch an employee stock option plan, but there are moments when it becomes especially valuable.

Most startups introduce an ESOP:

• after raising their first institutional round (seed or series A)
• before ramping up hiring
• when transitioning from an early team to a more structured organization

Before rolling one out, ask yourself:

• do I need to compete with bigger companies for talent?
• am I ready to align my team around shared, long-term goals?

If you’re nodding yes, you’re ready for an ESOP.

Frequently asked questions

1. Who is eligible for ESOPs in a startup?

ESOP eligibility varies based on company policy and local regulations. While ESOPs typically cover full-time employees, some jurisdictions also allow advisors or consultants to participate. Companies may further define eligibility based on tenure, job performance, or specific milestones. Clearly outlining these criteria in your ESOP plan is essential to avoid confusion.

2. What is the vesting period for ESOPs in startups?

The vesting period is the time over which employees earn the right to exercise their stock options.

The most common vesting schedule is the 4-year vesting with a 1-year cliff. Employees earn a percentage of their options over four years, but they must stay with the company for at least one year to earn their first chunk. After that, the remaining options typically vest monthly or quarterly

Some startups also tie vesting to specific performance milestones or company goals.

4. Can a startup cancel an ESOP plan?

Yes, a startup can cancel or modify its ESOP plan, but this typically requires approval from the board of directors and, in some cases, the shareholders. Changes to the plan must be communicated clearly to employees, as any modifications can impact their rights and benefits. Canceling an ESOP plan is rare and usually happens only under specific circumstances, such as significant company restructuring or changes in business strategy.