How should companies manage ESOP in their cap table?

ESOPs have been identified as one of the most preferred funding tools in the current era. While ESOPs were traditionally used to incentivize long-tenured senior management, recent trends show that they are now actively used as a recruiting strategy to recruit, retain, and attract talent. It encourages employee ownership by making them part owners, which aids in accelerating business growth and performance. Startups typically give employees early access to ESOPs, aligning their wealth with the Company’s prospects. As a result of recent IPOs and investment booms in young businesses, ESOPs have also gained prominence. While the overall concept of these Options may be difficult to grasp, ESOPs, as a costly tool, must be used with caution. 

This article will focus on using cap tables for ESOP management, ESOP management software, Types of ESOP in cap tables & more. 

ESOP management and cap table 

An ESOP trust that has purchased shares should be listed as a shareholder on a cap table for ESOP management, regardless of whether the shares have been fully allocated to the participant’s accounts. A Cap Table, also known as a Capitalisation table, is a spreadsheet for startups or early-stage ventures that shows the company’s equity capitalization. The table shows who owns which equity shares, warrants, stock options, convertible securities, and the price paid by investors for these securities. 

Understand employee stock option plan( ESOP)? 

Employee Stock Option Plan is a plan or scheme in which the company offers its shares to its employees at a predetermined price, usually at no or low additional cost, at a future date. Employee stock options are rights or options granted to employees to purchase shares at a later date. These are NOT shares in and of themselves.

Employee stock ownership plans, or ESOPs, allow workers to purchase business equity. The ESOP’s goal is to assist workers by encouraging, motivating, and keeping them interested in their jobs for a long period. Employees may purchase the company’s shares at a specific price after a set time, like regular stock options in private corporations (strike price). A firm must employ an employee for a certain amount before they may vest their shares under an ESOP.

Let us just go through an ESOP scenario to understand the procedure better. Let’s say a business offers 2,000 shares to employees as part of stock options. Let’s assume that after five years of service, the employee will become the owner of the 2,000 shares at the strike price of $10/share. The employee can purchase 1,000 shares after five years.

Why should companies have ESOP? 

Employee stock options (ESOPs) are used by businesses to attract and keep the best workers by giving them stock in the business. The employer will distribute these shares in stages. Employees would be encouraged to remain with the firm longer to qualify for option grants. 

Stock option confronts the biggest hurdle in the HR industry, i.e., the high attrition rate. By providing employee stock option plans, the firm could reduce its high turnover rate. Additionally, many of these firms are cash-strapped and unable to provide a significant beginning pay. As a result, they provide a share in their business, making their package competitive and attracting brilliant individuals.

How does a cap table work for ESOP?

Whether or not the shares have been completely distributed to the participants’ accounts, an ESOP trust that has acquired shares should appear on a capitalization table as a shareholder that owns the whole amount of shares it purchased.

The legal owner of the shares held by the ESOP trust is the ESOP trustee. Still, the plan participants are the beneficial financial owners of shares allocated to their accounts subject to vesting rules. In some limited circumstances, US federal law requires that the vote on specific shares be passed through to the participants, but this does not make them individual legal owners of the shares in terms of capitalization.

Individual characteristics of the participant may be relevant for some purposes and in certain instances, such as minority and/or women-owned business enterprise (MWBE) qualification and other preferences, but this has no bearing on corporate law or capitalization. Some countries have ESOPs that are not the same as those in the United States, and they could be treated differently.

The critical details relating to ESOPs that need to be included in the cap table are

• Grant Date – The day when the employee receives their ESOPs.
• Vesting terms – How long an employee must stay with the company to qualify for exercising his/her shares and what they must do to be eligible.
• Vesting period –  Time between the grant date and the day the ESOP grant’s stipulated vesting requirements have been met.
• Exercise Period – Time to purchase the shares after vesting. 

Types of ESOP cap tables include

The ESOP sheet is where all of your employees’ shares are recorded.

There are two types of options to consider:

ISO/NSO

These are options in American parlance. You can change the names in the Format sheet to whatever you want but don’t change the “RS” name because the model looks for it, and the formulas will complain. These are your standard share options, which you will most likely give to employees.

Restricted Stock 

All of those are effective shares. They are issued from the ESOP pool, so you must deduct them. And then add this sheet to the common street. The easiest way to understand this functionality is to look at the double entry. You can see the example in the ESOP and common sheets and the adjustments and comments made.

How can companies manage ESOP in their cap table?

Startups typically have a small number of equity owners, who are often family, friends, and angel investors. Such owners must have a realistic view of their stake as the company grows and receives additional funding from sources such as venture capitalists or a public IPO. 

The cap table will be useful and updated after each subsequent funding round, demonstrating how ownership is diluted and spread across new owners as the company grows. 

A more complicated table might include details on possible new funding sources, mergers and acquisitions, public offerings, or other hypothetical transactions. A well-represented ESOP Pool in Cap Table attracts investors, resulting in startup funding raining down on their operations. Investors become interested when confident that no further dilution will occur until the next fundraising round.

Elements a cap table should include to reflect ESOP

Some of the vital points that should be included in the ESOP Cap Table are –

• Grant date –  The date the employees are hired is the date they are granted, called the grant date. 
• Vesting – The period an employee must be associated with the Company to obtain a specific benefit.
• Vesting period – The time between the date of the option grant & the date on which the employee is eligible to exercise the option under the ESOP Scheme. The law requires a one-year minimum vesting period.
• Exercise Time – Available to exercise the shares after they have vested.
• Shares available – Number of shares offered by the company to the employees through ESOP.
• Percentage stake -Defines the employee’s stake in the company if they exercise the options.
• Price of Exercise – Strike price or price at which employees can buy the given shares. It is predetermined in the contract. 

Cap table management for ESOP

The first step is to enter the name of each staff member in the names field, followed by the date they were granted in the Grant Date field. The grant date is tied to the board date. You must hold a board meeting before presenting options to the staff! I’m assuming the board date is the same as the grant date. Furthermore, the vesting start date (when the clock starts) is what matters, and there is a linked formula to the board date, assuming that the board date is when vesting begins. 

How many options do you give your employees? Add these to the No. Options section. Select the appropriate option from the dropdown menu. If you’re unsure, choose ISO and forget about it.

Finally, factor in the Exercise Price. When allowed, this is the price at which staff can purchase those options.

There are checks at the bottom to ensure that the options and RS in the common sheet add up! You must perform double entry; these checks ensure you do not make a mistake! 

How can different types of ESOP affect the cap table? 

Let’s see how different types of ESOP affects the cap table below.

Stock options

Options are a contract between a company and a receiver that allows the receiver to buy or sell shares at a fixed price before a specific date. These are typically given to investors, founders, or employees as a thank-you for their contributions to the company. The grant date, receiver, number of shares, cost, strike price (fixed price), vesting start date, and exercise date should all be included in an option (if any). The company’s overall cap table may be impacted if the option contracts are exercised.

Restricted stock

Restricted stock is unauthorized company shares that are typically issued to individuals, such as the company’s executive or directors. These shares are non-transferable and must be traded by SEC (Securities Exchange Commission) regulations. These are typically issued as a form of employee compensation because they are often fully vested after certain conditions, such as continued employment or achievement of specific goals, are met.

Restricted stock units(RSU)

Restricted stock units, similar to restricted stock, are also provided when certain performance goals are met. They differ in that, similar to options rights; these employees are not initially issued shares until the vesting period is complete. This can be advantageous for the company in certain circumstances because it does not immediately dilute the share number, which makes bookkeeping and taxation easier until the stock units are converted to shares.

How ESOP or cap table management software can help you?

Businesses often manage their ESOP and a cap table on Excel sheets, which might be manageable during the early stages of the business. However, as the business issues more shares through ESOP, excel sheets become increasingly complex. Due to this, tracking with Excel sheets makes your cap table prone to expensive errors. 

Consequently, organizations providing ESOP are strongly urged to use cap table software since it helps lower risks and mistakes. The flaws that are often present in Excel sheet layouts are eliminated with the help of Eqvista’s cap table software.

Why should you choose Eqvista’s ESOP management software?

A simple and easy-to-use cap table is crucial for ESOP management. When using Cap tables, ditch regular Excel sheets and employ Eqvista. All users may employ Eqvista’s ESOP management software, which effectively provides database administration and analytical capabilities helpful for managing data, making decisions, and other tasks. The cap tables from Eqvista include all the information required to monitor your company’s ESOP and personal data on each employee. Contact us today to learn more.