In Volume 3 of The basics of ESOPs, we talked about what’s the best time to create an ESOP pool and what happens when an employee leaves before the options are vested. In this volume, we will talk about the exercise of these ESOPs.
How should an employer select the Exercise Price?
If you give them an exercise price close to the market value, they will be paying for the shares when they exercise and only be earning the premium (the increase in value from today's stock price to when they sell) that they create while employed with you. Giving ESOPs at face value implies that you are also giving them the value created by the team so far along with the above.
Remuneration lower than the market level
If you are granting ESOP benefits to your employees in lieu of salary, with the objective of making up for the lost compensation for an employee who has taken a huge salary cut and joined a start-up, it is only fair that the ESOPs be granted to the employee at an exercise price which is as low as possible. Typically, that would be the par value (or the face value) of the shares. The typical face value is INR 10, though, it differs from company to company. It would be advisable to check the face value of your company’s equity shares before finalizing the exercise price.
Market level remuneration
If your employees are already drawing market level salaries and the stock options are granted to them in the form of added incentive or bonus, then the exercise price of the options should be higher. For example, if you are granting ESOPs soon after a fundraising round, then you could use the valuation of shares assigned by the investors in such a round as the benchmark. So, if you have issued shares at a price of INR 100 per share to the investors, you could fix the exercise price at INR 100 per share or maybe at a discount to the fair market value, for instance, INR 80 per share.
Watch this space for Volume 6 of the Basics of ESOPs series by Qapita where we will talk about the liquidity options.