Strategic Considerations for ESOP in Low-Return Startups

ESOPs are often touted as an extremely lucrative way to generate wealth due to the high growth rate of startups. Such expectations are often fueled by events such as ByteDance offering buybacks at a valuation that was 34.53% higher than the year before.

However, it can be valuable even in low-return startups if they are structured correctly. Through this article, we will help you do just that. First, we will identify the factors that determine the value of ESOPs from the perspective of employees. Then, we will turn these insights into actionable strategies for structuring.

What makes or breaks the value of ESOPs?

Employee Stock Ownership Plans can be valuable incentives, but their actual worth hinges on a range of financial, operational, and governance factors. Below is an overview of what drives or undermines ESOP value.

Growth potential

ESOPs are a great way to attract talent, primarily due to their high growth potential. After all, a startup can grow much faster than established companies. This growth potential is augmented by the fact that it allows employees to purchase stocks at discounts to the intrinsic value.

Lack of access to similar investments

Another factor that contributes to the appeal of ESOPs is the difficulty individuals face when investing in startups. Investing in listed companies does not require any minimum income or asset level. However, startup investments through venture capital funds or as an angel investor are more accessible as a qualified purchaser or accredited investor.

Liquidity

One factor that reduces the value of ESOPs is the lack of liquidity. If the startup does not offer exits, the holding periods of employees may stretch as long as those of venture capitalists. Presently, the average tenure of PE and VC funds has increased to 13.1 years. While high-net-worth individuals with large diversified portfolios may be able to endure this, we cannot say the same for all employees.

Opacity

Employees may underestimate the value of ESOPs because of opacity regarding performance and valuation. Startups do not need to make the same disclosures as publicly listed companies, which makes it challenging to assess the present value of ESOPs. An adverse impact of this opacity is baseless speculation, which further reduces the value of in the eyes of employees.

How can you increase the value of your startup’s ESOPs?

Consider implementing the following six strategies to improve the employee perception of ESOPs.

Increase returns by offering a discount

If your stock options have low returns, you may need to compensate for the same by offering a large discount. While this is a very obvious strategy, you must not underestimate its impact. Let us understand this with an example.

Suppose Fingram is a high-growth fintech startup while Koala Fin is a low-growth fintech startup. Fingram’s ESOPs have an exercise price of $40, which is the same as its share price. On the other hand, Koala Fin’s exercise price is $15, which is $5 lower than its share price.

In the most optimistic scenario, over the next 5 years, Fingram’s share price can grow by 30% annually while that of Koala Fin can grow by 10%.

So, the expected gains from the stock options of each company can be calculated as:

Particulars	Fingram	Koala Fin
Stock price	$40.00	$20.00
Exercise price	$40.00	$15.00
Vesting date gain per share	$0.00	$5.00
Growth rate	30%	10%
Capital gains over the next five years	$108.52	$12.21
Total gains per share	$108.52	$17.21

Fingram’s ESOPs may appear more lucrative than those of Koala Fin at first glance. However, Fingram’s ESOPs are more difficult to exercise, and their value is entirely dependent on future performance, making returns highly variable. In contrast, Koala Fin’s ESOPs are easier to exercise due to the lower exercise price and position the employee for positive returns from day one.

Note: Despite lower growth rates, immediate value from discounts makes ESOPs more attractive and less risky.

Appeal to the tax-saving potential of ESOPs

The second most appealing benefit of stock options for an employee is the tax benefits. In the USA, the top marginal tax rate can be as high as 37%. However, the tax on capital gains on stocks is capped at 20% if held for at least one year.

As of 2025, for any income above $48,475, the marginal income tax rate is higher than the long-term capital gains tax rate. So, stock options can be tax-efficient for employees of all income levels.

You can help magnify these tax benefits easier to achieve by educating your employees about early exercising through 83(b) elections.

Note: ESOPs provide 7-17 percentage point tax savings at all income levels.

Strategically implement buybacks

ESOPs of a low-growth startup can appear more valuable than a high-growth startup if the only one that offers buybacks. The greatest risk of receiving ESOPs is the lack of liquidity. If a startup does not get acquired or go public, selling stocks from is extremely challenging.

Aileen Lee pointed out that 93% of unicorns are actually papercorns, i.e., privately held unicorns that are yet to provide exits. Such reports shake the confidence of employees in the likelihood of a successful exit.

But, suppose your startup has a periodic buyback policy wherein you are committed to having the purchase price at least as much as the FMV on the vesting date. Then, you are not only ensuring liquidity but also protecting employees from losses.

Note: Monthly vesting creates regular positive reinforcement, making equity feel more tangible

Tweak the vesting schedules

Typically, stock options begin vesting after a 1-year cliff and over 4 years. It takes 5 years to receive the equity from a single grant. Such lengthy vesting schedules make equity seem like an unattainable benefit to employees. Hence, shortening the vesting schedule can help you augment the value employees see in ESOPs.

Some founders might think that employees would not stay loyal with short vesting schedules. If that’s the case, you can tweak the vesting frequency to make ESOPs look more attainable. Some ESOPs vest every quarter or annually. You can change this to every month.

For instance, 12,000 stock options are supposed to vest for a certain employee in 2026. Normally, this would mean 3,000 stock options vesting every quarter. However, with monthly vesting, 1,000 stock options vest every month. Then, the recipient of these stock options will be reminded of the value of equity more frequently.

Trust through transparency

By transparently disclosing information about startup performance and third-party transactions, you can enable employees to independently assess the value of ESOPs. Transparency helps employees understand the true value of their ESOPs and builds trust by demonstrating that the company is acting in good faith.

Furthermore, it also encourages employees to think like owners. Instead of simply expecting a wealth generation opportunity, they will investigate how their own performance links to the overall organization’s performance. They will think about what they could have done differently or how they could have contributed more to the team to ultimately increase their own wealth.

Educate employees on the value of equity

Even a low-growth startup’s ESOPs can be valuable because of improved vesting schedules, liquidity, transparency, and discounts. It can provide returns higher than those of other investment avenues such as stock market investments, bonds, mutual funds, or exchange-traded funds (ETFs).

However, your employees may not have the skills to make this assessment. Hence, it is extremely important to educate your employees about finance, especially about ESOPs and their taxation.

Most startups might not be able to internally develop an entire employee education program. If that’s the case, you can provide access to online courses of your choice. Then, you can focus on developing material that helps employees apply their learnings in the context of your ESOPs.

Eqvista – Unravelling the value of equity!

Offering stock options at a discount means that you cannot avail the tax benefits of incentive stock option (ISO) treatment. However, since the introduction of the alternative minimum tax (AMT), these benefits have diminished greatly. So, in the present tax environment, it makes even more sense for low-growth startups to issue stock options at a discount to make them appear more attractive to employees.

For more such tax-aware insights on stock option structuring, consult Eqvista’s experts today!