An Employee Stock Option Plan (ESOP) allows employees to own a piece of the company in the future and benefit from its growth. Startups use ESOPs to attract and retain talented employees and manage the vesting of options over time. This guide covers the key aspects of setting up and maintaining Employee Stock Option Plans for startups in Canada.
Why create an Employee Stock Option Plan?
Most startups have big plans to grow their workforce and scale operations. And they will need great employees to get there. Options are a huge incentive for new employees to join a startup rather than a large established company. Knowing that early-stage startups probably can’t match the salaries paid by industry leaders, options provide a lucrative form of compensation that will grow in value over time.
How do Employee Stock Options work?
Instead of buying shares in the future and paying the future price (after the company has become more valuable), options allow employees to purchase shares in the future at their present value. Assuming the company grows over time, options will allow the employee to purchase shares at a significantly reduced price to future shareholders.
As an example, Employee A is granted 10,000 options. The current price of each share is $0.01. In a few years, the company’s price per share has grown to $1. When Employee A exercises the options (which is the technical term for purchasing shares based on options), they will pay $0.01 per share for 10,000 shares, for a total of $100. However, the true value of the 10,000 shares is now $10,000. So Employee A has purchased shares for $100 that are worth $10,000, meaning Employee A has profited $9,900 in addition to their regular salary.
What is an Employee Stock Option Plan (ESOP)?
An Employee Stock Option Plan outlines the policies and rules for how employees can purchase shares in the company at a favourable price sometime in the future. An option is simply a contract between the company and an employee saying that on a certain date in the future the employee will be able to purchase shares in the company at a set price. However, to ensure options are distributed fairly and on terms that make sense for all shareholders in the business, the ESOP contains all the high-level terms for offering options.
The ESOP will have implications for the company’s long-term ownership structure, but no money needs to be exchanged at the time the ESOP is created. The ESOP covers the timelines and circumstances where share purchases can be made in the future.
In this guide, we cover all the major elements within an Employee Stock Option Plan, including the Option Pool, Option Award Agreement, Exercise Price (aka the “Strike Price”), Expiry Date, and Vesting Provisions.
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