Esops in start-ups don't guarantee a windfall

Understand the terms and condition for vesting of employee stock options before you opt for them

Imagine you join a start-up and are made part of an employee stock option plan (Esop). You work hard and contribute to the company’s growth. The start-up gets acquired. The founders make money, the investors make money, but the employees don’t get to offer their stocks in this deal.

This may run contrary to the popular belief that Esops are a wealth creation tool, but there have been many cases where employees have ended up being disappointed, even felt betrayed. "Sometimes an employee doesn't understand the fine print or how the ESOP policy operates. When a start-up is acquired, the deal could be structured in a way that it does not trigger the vesting clause immediately on the acquisition," says Archana Tewary, partner, J Sagar Associates.

There could be other reasons for employees not getting an immediate compensation for the Esops they hold. The acquiring company may sometimes offer its own shares by swapping the existing Esop programme. Then there are instances where the acquirer may want to retain the current employees and may hence defer the vesting of Esops, or allow only partial vesting.

When joining a start-up, therefore, it's essential that employees go through the terms and conditions of the programme, and read the clauses therein before signing the agreement. "Many employees get a shock or feel betrayed when they either leave a start-u, or when it is acquired. It's only in such events they realise that Esops come with riders," says Mohini Varshneya, head-ESOP services, Corporate Professionals.

Recently, former employees of a Mumbai-based start-up sued the company alleging that they had been wrongfully deprived of gains on their stock options when it was acquired by a foreign company. When redBus was acquired, many employees were unhappy as the deal didn’t trigger immediate vesting of stocks, according to media reports. There has also been a case where former employees of an information technology company were not provided with a copy of the contract. When they approached the management a few years after leaving the company to vest the Esops before expiry, they were told that they were supposed to vest the options within 90 days of leaving the start-up.

Due to limited funds, start-ups usually hire employees at a salary lower than the levels prevalent in the market. To compensate for the lower pay, employees are offered  Esops, which hold the promise of a windfall when the company starts doing well and is either acquired or comes up with an initial public offer. "While Esops have become more common, there's no guarantee when employees can exit them,” says Varshneya.

Before joining a start-up, read the exit clause it offers. Understand what will happen to your Esops when you quit the company or if the employer terminates your services. If the norms include 'conditional' acceleration or acceleration clause that allows for alternatives, it would mean that the exit would depend on the acquirer or investors putting in money.

Unlike in countries like the US, where employee rights are well protected by law, Esop regulations in India are not as stringent. While the Companies Act does talk about the rights of employees pertaining to Esops, there are no punishments or penalties if a company refuses to adhere to them. You will need to file a case in a civil court to get remedy.