What is the ESOP? Why is it relevant?
Some companies, mainly in the US, offer Employee Stock Ownership Plan (ESOP) to their workers. It consists of granting stock options as a part of the salary. Stock options are the right to purchase a given quantity of shares at a set price for a fixed period (usually 10 years). A right is not an obligation.
This procedure was popularized in Silicon Valley and they have proven it to be efficient when scaling and investing in startups.
It is especially useful for companies that are still starting, that have limited cash, but near limitless potential. By giving stock options to employees, they are investing in the future, and they can hire the professionals needed to succeed. Another potential use is that, since the stock options are a remuneration in the long term, they are ensuring the retention of talent.
Moreover, startups have a reputation for paying lower salaries. The gap between startups and established companies is narrowing. However, they still need to offer many other retributing if they want to be able to attract competent workers’ attention. Stock options are a valuable asset in the competition to hire and retain top talent.
The creation of this article is possible thanks to the book Rewarding Talent from Index Ventures which provides the theoretical framework. Further analysis into markets, sectors and companies is extracted from TalentUp’s database.
How does the ESOP work?
As previously mentioned, stock options grant the holder the right to buy shares at a set price within ten years. It is also known as the right to exercise the options at the strike price.
The right to buy more shares increases with time. It is possible to buy a further 25% of the own shares at the end of each year, for four years.
The price is paid in exchange for ordinary shares in the company. These shares, later on, can be sold or can be retained in hope that their value will increase in the future.
ESOP gives the employees the option to hold shares, just if they want. Employees who do not want to inquire about any risks will prefer not to exercise their rights. It makes sense to allow them to decide instead of giving them the shares directly since the willingness to take risks differs in each individual.
Moreover, in the US it is quite extended since ESOP does not have any premium or tax to pay upfront (while shares have it). It benefits both the company and the labour force.
Other territories, like some European countries, have different regulations and this practice may not be beneficial. This is the case of Australia, Denmark, Netherlands, Switzerland, Norway, Czech Republic, Finland, Austria, Spain, Germany, Belgium… among others. Even so, other practices encourage workers to hold shares that also reach for employees’ commitment.
Why should companies give out stock options?
The main advantages of ESOP are:
- Hiring → The commitment and the possibilities to grow that ESOP offers are unmatched by higher salaries in bigger companies. It is attractive for possible employees and it helps recruiters to be taken into account.
- Retention → The stock options vest over multiple years, which creates disincentives for leaving. Employees will have ongoing reasons to stick with the company.
- Motivation → Having a personal stake in the success of the company encourages employees to work harder and be more ambitious. Management wants to have the commitment from workers and having an ESOP is a way to ensure it.
- Alignment → Stock options direct all employees towards the same goal – the company’s overall, long-term success. They act as an incentive for collaboration.
Having said that, the general context of the country may create problems to implement it.
Applying ESOP is more or less easy depending on plan scopes, the strike price, the levels of bureaucracy assigned to minority stakeholders… Taxes can also represent a disadvantage if they are highly applied in different stages of the procedure. Taxes can be a problem both for the employee and for the employer.
What kind of companies do apply ESOP?
80% of the business offering this compensation plan are from the information technology sector. Telecommunications and consumer services both represent 5% each of the total companies with this plan. Other sectors still need to explore the possibilities given by ESOP.
The specific positions with stock options plans are usually backend developers, full-stack developers and frontend developers. This information reinforces the strong relationship between IT companies and the ESOP.
At the first glance, it is obvious that the positions enjoying ESOP have much higher salaries on average than other workers from the same sector.
It is also relevant to say that the average seniority stage for ESOP workers is 5, while the general average is 2. More seniority is strongly related to higher salaries.
Countries and hubs where stock options are a common compensation option
Approximately, 78.7% of the ESOP given worldwide, happen in the US. The following countries are New Zealand (5.8%), India (4.7%), Canada (3%) and the UK (2.7%).
The classification by continents is 81.1% North America, 6.5% Asia. 6.2% Oceania and 5.9% Europe. ESOP practices are completely irrelevant in Africa and South America.
Inside the US, 47.57% of ESOP are implemented in California (which includes Silicon Valley) and 27.82% in Washington State. It means that this reward system is mainly popular on the US West Coast.
ESOP in Europe
There is wide variation in national policy across Europe. Regulations and tax frameworks are radically different across countries. Estonia, the UK, and France are the most supportive countries of employee ownership.
Estonia has the most favourable approach of any country reviewed globally.
The UK’s EMI scheme and French BSPCE are both better than what is available in the US. Other countries, including Germany, lag behind in what policies concern.
The UK government has some entrepreneur-friendly regulations about stock options, which establish the country as the European leader in ESOP. However, policies are even friendlier in the Baltic countries and yet none of them reaches the Top 12 European countries applying ESOP ranking.