the definitive guide to

STOCK BASED COMPENSATION

FOR EMPLOYEES
Stock based compensations
for your organization
Mar 2019

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To win in the marketplace
you must first win in
the workplace.
- Doug Conant
Former President & CEO, Campbell Soup Company
 +92%
1.9
+57% X +62%

5.2 1.6 +36%

X
1.4
X

3.4 X X X

ESOP Companies
Non-ESOP

Non-ESOP

Non-ESOP
S&P 500
ESOP

ESOP

ESOP
Average Tenure Average Average Increased
in the company Household Returns Growth
in years Income 2002-12 over 10 years
WHAT IS AN ESOP Defines the coverage
of employee levels of In order to use the method,
the plan, e.g., senior you need to be registered as a
management only in corporation with shares or
this case. similar stock units.

Equity/ Stock-based compensation

is a method by which corporations
use options to buy stock at
subsidized/ no cost usually at a
Usually priced so that future date to incentivize, retain
employees can own
stock units at a price
lower than fair/
and reward their employees/
traded market value
when they are advisors.
eligible to buy.

Incentivize. motivate or encourage to do something

But only to company’s/ parent
Retain. keep someone engaged in one’s service
company’s/ subsidiary’s/ holding
Reward. give something in recognition of service,
company’s employees.
efforts or achievements
 2015 ESOP AMA Correlates of
Survey, EO Blog, Jerry L Employee
GOOD FOR EMPLOYEES
Less 24% Conventionally held
Foundation Ripperger Satisfaction
likely to 13% Companies with ESOP plans
Employee Ownership
Foundation's 21st Annual
Economic Survey
How Employee Ownership
Benefits Executives, Companies,
and Employees
Journal of Applied Psychology,
study by KJ Klein & RJ Hall,
University of Maryland

leave % of employees considering seeking employment elsewhere

Earn $30,000 Conventionally held of companies that said ESOP

more
wages
$40,000 Companies with ESOP plans

median pay from wages across industries and levels

93% deployment benefitted the
company

Accrue $14,831 Conventionally held

of companies that said their
more
wealth
$28,500 Companies with ESOP plans

median household wealth of employees across industries 83% company’s stock value increased on
external appraisals

Receive 39% Conventionally held

more of companies said it positively

benefits
69% Companies with ESOP plans

employees provided with other benefits additionally 77% impacted employee morale and on-
job performance

2018 NCEO 2018 ESOP Statistical

said profitability said revenue
Annual
Survey
National Center for Employee
Economic
Performance
Performance of ESOPs in
Profile on
EOs
National Center for Employee
increased 69% increased 78%
Ownership Survey read with organizations by BKD, CPAs & Ownership with Department of
2018 Update Advisors Labor for 2015

EQUITY
Employee Stock Option Plan (ESOP), Incentive
Stock Options (ISO), Employee Stock Purchase
Plans (ESPP), Non-Qualified Stock Options
(NQSO/ NSO)
Allows employees to become share
holders at a future date and at a pre-
determined price, usually lower than the
fair market price.
I want my employees to be
owners like me.
Investors would want me to
have ESOPs to retain talent.
We are expecting to go public/
get acquired someday soon.
RESOURCES
Investopedia
ISOs
Definitions of key phrases relating to
the meaning, statutes, advantages &
disadvantages of concepts
MORE THAN ONE WAY
AWARDS MIMIC
Phantom Stocks, Stock Appreciation Rights
Restricted Stock Units (RSU), Unrestricted Stock
(SAR), Profit Pool, Strategic Deferred
Unit (USU), Common Stock Alternative (CSE)
Compensation Plans, Profit Unit Plan (PUP)
Allows employees to become share Mimics equity interest but without
holders today but applies restrictions on altering or modifying the cap table to
the transferability or ownership to incentivise employees for current and
safeguard company interests. future performance.
I want my employees to have a I want them to partake in
share of our success subject to... liquidity events.
Flexibility to operate and option I believe their contributions are
to buy-back is paramount. specific to certain areas mostly.
I need to reserve certain rights Stock dilution may impact me
Need
as my investor wants them. negatively in this scenario.
help?
Investopedia
Investopedia Morgan Stanley Investopedia PhantomStock PhantomStock
RSUs RSUs Phantom Stock
NQSOs Types of Plans Whitepaper
Definitions of key phrases relating to Understanding RSUs, how to
determine whether you received an
Definitions of key phrases relating to
the meaning, statutes, advantages &
& SAR Types of Phantom Stock plans, Definitions, types, uses, meanings,
the meaning, statutes, advantages & Definitions of key phrases relating to meanings, advantages, uses of each advantages and disadvantages, who
disadvantages of concepts RSU, restrictions, taxation disadvantages of concepts type and related disadvantages uses what, when and how these work
the meaning, advantages +
disadvantages
 RESOURCES

SOME HOT TERMS GRANT Issuing a stock option award to an employee usually read in
conjunction with his employment agreement and statutes
Need
help?
ESOP Cheat
Sheet
Alexander Jarvis Blog 50
Schedule of when what portion of Folds on ESOP Terms

The time period that an
employee needs to wait for/
milestones which need to
VESTING be reached/ performance
that needs to be delivered
when the employee can
apply to receive the stock.
Vesting Schedule
stock becomes eligible for exercise
Procedure for premature vesting in
Accelerated Vesting
situations such as buy-out/ merger
Single/ Double Trigger of sale +/- ESOP, The
Trigger Vesting
employee exit that leads to vesting
Employers
Time period during which no Perspective
Cliff Vesting
vesting happens till a certain date
Cleartax Blog on Key terms in
ESOPs and what they mean

Act of buying the stock unit Time period when option holder
Exercise Period
by paying the ‘Exercise
EXERCISE
can apply to receive stock units
amount’, if any, to convert the Period for which the Exercise Regulators
vested options to actual stock Maturity & ESOPs in
period stays open
India
Nishith Desai Associates
whitepaper on ESOP terms

Price that the option holder

pays in order to acquire the VALUE OF
STRIKE PRICE stock units which he is INCENTIVE
FMV OF THE
SECURITIES
AFFORDABILITY
TO EXERCISE
AWARDED
entitled to which is based on: Accion ESOP
Whitepaper
Best practices in ESOPs and
term used with examples
 Set up the Analyse the Establish the Draft the Structure Communicate
single line impact on legal ESOP Scheme Awards to the awards
objective everyone framework & Rationale incentives right

Set up an ESOP Obtain approval of Obtain approval of

Committee with ESOP Committee of ESOP Committee
members from Founding Plan, Coverage and and Compensation
team, KMP & HR Quantum Committees
 Set up the Analyse the Establish the Draft the Structure Communicate
single line impact on legal ESOP Scheme Awards to the awards
objective everyone framework & Rationale incentives right

Set up an ESOP
Committee with
members from Founding
team, KMP & HR
BEING OBJECTIVE Structure is based on the goal of the plan,
e.g., retention as a key goal would define
length of vesting cycles/ encouraging
ownership would define the exercise price.
A simple
Defines the coverage
of employee levels of To encourage, motivate comprehensive
the plan, e.g., senior
management only in and retain employees single sentence
this case.
contributing to the objective
overall management by statement
enabling ownership A single sentence goal
statement allows all
This is important to
while allowing them to stakeholders to be on the
decide on the type of
plan, e.g., using a
accrue personal wealth same page as to why the
proposed plan is being setup
Phantom stock award
when ownership is
and gain from the and who it wishes to reward/
incentivize. This ensures that
not the objective. growth of the company. future stakeholders are also
This allows to decide on the in the know and aligned to
This defines the performance
goals that the plan may be quantum, tenure and conditions the long-term objective.
attached to, e.g., revenue goals, for exercise, e.g., holding period
investment goals or profit goals. lengths before sale.
Set up the Analyse the Establish the Draft the Structure Communicate
single line impact on legal ESOP Scheme Awards to the awards
objective everyone framework & Rationale incentives right
 ANALYSE THE IMPACT
RESOURCES
Impact on future cash
ON THE COMPANY Timing of grant and plan,
flows, Ability to right communication to
compensate in cash, Tax employees, management
The Hartford considerations at time of perception of risk factors,

NON-FINANCIAL
Magazine on
ESOPs
exercise, Cost of setting growth path visualized,
ESOP factors to consider and the up and administration, need to having loyalty
FINANCIAL

next generation

buy-back need, Valuation from team

expected over time
Money Today,
How to use
ESOPs
ESOPs SOPs By Tanvi Verma

Value of incentives, Potential for growth,

ability to afford exercise, control in organization,
withholding tax selection of the right
Business
Standard,
requirements, payoff at personnel for allotment,
Using ESOPs exercise, salary-ESOP timing of exercise,
productively trade-off, other benefits alignment of incentives
Risky but profitably
provided to objectives/ plan
ON THE EMPLOYEES
Set up the Analyse the Establish the Draft the Structure Communicate
single line impact on legal ESOP Scheme Awards to the awards
objective everyone framework & Rationale incentives right
 RESOURCES
Need
Rule 701, help?
UpCounsel
Process, conditions to Separate
be fulfilled for availing Sanction by Special Separate Resolution
Resolution
safe harbour benefits Resolution by the for grants to parent,
for Additional
Shareholders subsidiary employees
issues to employees Authorisation for

EVALUATE
SEBI granting of ESOPs
Regulations
on ESOPs Determining the Transferability, -
Employee stock option Minimum Vesting Decision on Lock-
scheme and employee Exercise Price Non-transferable, or
Period in-period post
stock purchase scheme
(accounting norms cannot be
guidelines, 1999 of 1 year from grant exercise
and incentives) encumbered
Setting up the
scheme
Changes in
Tax on ESOPs, Maintenance of
Forbes India Exercise conditions, Forfeiture/Refund on
Registers
Changes in Tax Structure Will process, legal heirs, expiry/ non-fulfilment
Impact ESOPS of Employee Stock
incapacity of vesting conditions
Grants, Exercise
Clarifying
exercise
How ISOs are
taxed, The
Balance Disclosures in BoD Disclosures of the Variation from the
Taxation and impact on ISOs in
US and under the tax reforms
Report Scheme ESOS
summary of movement & Framework -Execution Approval by special
financial impact - Reporting resolution
Communicating
ISO taxation to stakeholders
detailed,
TurboTax
Taxation and impact on ISOs in
US and under the tax reforms
Set up the Analyse the Establish the Draft the Structure Communicate
single line impact on legal ESOP Scheme Awards to the awards
objective everyone framework & Rationale incentives right

Obtain approval of
ESOP Committee of
Plan, Coverage and
Quantum
 RESOURCES
Segment your
DECIDE AWARDS 1 teams by
function/ role
Founding Team/
CXOs
Senior Team/
VPs & Above
Functional
Teams
Support
Teams ESOP Best
Practices,
Accion
Define Best practices, model

2
Wealth examples, terms and
Rationale for % ownership $ incentives $ incentives calculators

Awards
accretion

Co-founder
Assign option Negotiate Equity

3
X times X times Calculator,
multiplier for Negotiate + X times Base
Base Salary Base Salary Foundrs
contribution Salary Objective way to assess
value of co-founders &
founding team
% holding at
maturity
X Base Salary Base Salary Co-founder
Assign $ value Valuation at $ value of holding X X
4
Equity Split,
to stock maturity + Option Multiplier Option Multiplier Gust
options X $ value of award = = Objective way to assess
value of co-founders &

Discounting factor $ value of award $ value of award founding team

=
$ value of holding
Getting the
% holding $ value of award $ value of award value of stock
Compute X # of equity units / Last Base Value / Last Base Value options,

5 Awards
offered
Total Equity Units
=
of methods to left
& right
discovered x Total
Equity Units =
discovered x Total
Equity Units =
McKinsey
How to get the most of
your stock option pool
and awards

# of equity units # of equity units # of equity units

 Most commonly
DRAFT A SCHEME chosen by MSMEs

Vesting Tech Serv Manu Other Vesting Annual Quarterly Monthly

Period 4Y 4Y 5Y 5Y Frequency 70% 20% 10%

Most commonly Most trending

chosen by MSMEs

Exercise Low Med High Award Y1 Y2 Y3 Y4

Period 3m 6m 12m Allocation 30% 20% 20% 30%

Most commonly Most commonly

chosen by MSMEs chosen by MSMEs

Lock-in Low Med High Buy-back Yes No

Period 0Y 1Y 4Y Option 40% 60%

Need
help?
Set up the Analyse the Establish the Draft the Structure Communicate
single line impact on legal ESOP Scheme Awards to the awards
objective everyone framework & Rationale incentives right

Obtain approval of
ESOP Committee
and Compensation
Committees
 RESOURCES
Segment your
DECIDE AWARDS 1 teams by
function/ role
Founding Team/
CXOs
Senior Team/
VPs & Above
Functional
Teams
Support
Teams ESOP Best
Practices,
Accion
Define Best practices, model

2
Wealth examples, terms and
Rationale for % ownership $ incentives $ incentives calculators

Awards
accretion

Co-founder
Assign option Negotiate Equity

3
X times X times Calculator,
multiplier for Negotiate + X times Base
Base Salary Base Salary Foundrs
contribution Salary Objective way to assess
value of co-founders &
founding team
% holding at
maturity
X Base Salary Base Salary Co-founder
Assign $ value Valuation at $ value of holding X X
4
Equity Split,
to stock maturity + Option Multiplier Option Multiplier Gust
options X $ value of award = = Objective way to assess
value of co-founders &

Discounting factor $ value of award $ value of award founding team

=
$ value of holding
Getting the
% holding $ value of award $ value of award value of stock
Compute X # of equity units / Last Base Value / Last Base Value options,

5 Awards
offered
Total Equity Units
=
of methods to left
& right
discovered x Total
Equity Units =
discovered x Total
Equity Units =
McKinsey
How to get the most of
your stock option pool
and awards

# of equity units # of equity units # of equity units

 RESOURCES

DECIDE AWARDS Knowledge Industries Asset Intensive

Size of
ESOP Best
Option pool Tech BFSI Services Others FMCG Manu Others
Practices,
Accion by Industry 25% 16% 18% 16% 17% 16% 10%
Best practices, model
examples, terms and
calculators

Co-founder Allocation First 10 Next 20 Next 50 Next 100

Equity for Early Employees Employees Employees Employees
Calculator, team 5-10% 5% 5% 5%
Foundrs
Objective way to assess
value of co-founders &
founding team
Evaluate Co-
founder/ CXO
Equity Split CEO CTO/ CPO CFO CBO CMO CHR
Co-founder 2.5% 1.5% 0.5% 1% 1% 0.5%
Equity Split,
Gust
Objective way to assess
value of co-founders &
founding team

Delivery/ Sales/ Support

Allocation by Board Mgmt
Ops Business function
Getting the function 2% 7% 5% 5% 3%
value of stock
options,
McKinsey
Need
help?
Set up the Analyse the Establish the Draft the Structure Communicate
single line impact on legal ESOP Scheme Awards to the awards
objective everyone framework & Rationale incentives right
Amount in Value of ESOP
Pool as % of pool over
total equity
$1 2.00

funding stages
18 .0 0%

16% 16 .0 0%

$1 0.00

$10.26 14 .0 0%

$8 .00 12 .0 0%

11%
10 .0 0%

$6 .00

9%
8.00 %

$5.69 7%
$4 .00 6.00 %

4.00 %

$2.51
$2 .00

2.00 %

$1.17
$- 0.00 %

SEED EARLY EXPANSION LATE

STAGE STAGE STAGE STAGE
Round Angel, Seed Round Pre-A, A Round B, C Series E, F, PIPE, IPO
RIGHT MESSAGE

74% of the employees were dissatisfied with organizations’ measures to communicate.

- Ragan Survey, 2014

Changes in
Grant Option Award Exercise Tax
status/ tax/
Information Plan Agreement Process Implication
notification

Presented
Written Townhall Written Video Presented
Paper/ Email Paper Instructional Townhall Verbal
RIGHT MEDIUM

Video
Instructional
most effective

Written Written Written Online Written Written

Paper/ Email Paper/ Email Paper Intranet Email Paper/ Email

most used

Written Written Written Written Online

Verbal Paper/ Email Email Intranet
Paper/ Email Email

least effective
Starbucks’ communication of their stock option plan is right on. Clear, concise and friendly in demeanour. This
enables all employees to be clear and refer to it for any clarifications.

Communicating Grants Communicating Grant Communicating

& Plan Valuation Vesting & Exercise

GREAT CASE STUDY

Employees who believe that
management is concerned about
them as a whole person – not just an
employee – are more productive,
more satisfied, more fulfilled.
- Anne Mulcahy
Former Chairperson & CEO, Xerox Corporation
BONUS SECTION GOOD RESOURCES
BAD RESOURCES

Using Stock The CS

Stock Options
Options to Monitor Gene Marks
causing financial
dissuade Hostile ESOP
Inc.com, Is there a problem

harm
with your ESOPs

Takeovers gains as anti-takeover defence

Using Stock The Stock Options

Bloomberg
Options to Revive a Economist leading to exit of Why ESOPS are a Complete

flailing company key employees

Failure in India
An ESOP To The Workers

Using Stock The Menke Stock Options Inc42

Options to Group leading to
How ESOP exercise
conditions can cause overall
Facilitate The Original History of the dissatisfaction
ESOP and its role as a
dissatisfaction
Divestiture business succession tool
 REVENUE
AUGMENTATION
ESOP STUDY
SCHEME

BENCHMARK
STUDY
Now, can Prequate
help? strategic

Of
management
ESOP
AUDIT ESOP
VALUE STUDY

course GRANT
ESOP
REVIEWS
STRUCTURING

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Prequate is a management ^ finance advisory that acts and manages as a Business Finance, Strategic Finance & Management Assist
group. Over the last 8 years, Prequate has worked with 350+ businesses in 25+ industries across 20+ countries and has been covered
by various publications for its breakthrough approaches. Strategic finance for business impact.