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ESOPs for First Time Founders: How to Create the Pool, Use It Well, and Plan Buybacks

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ESOPs for First Time Founders: How to Create the Pool, Use It Well, and Plan Buybacks

You want to attract talent without burning cash. ESOPs are how you do it. This guide gives you a clear, founder friendly playbook. You will learn how to size and create an ESOP pool, how to grant and refresh it, how to design buybacks or secondary exits, and how to budget for the real cash impact, including buyback costs that should be planned in your P and L in practice.

Quick note. This is practical guidance, not legal or tax advice. Speak to your lawyer and CA before you press any buttons.

1) ESOP pool basics

What is it
 A pool is a reserved percentage of the company’s fully diluted cap table for employee equity grants.

Why it matters
 It sets expectations for hiring, reduces negotiation friction, and keeps dilution predictable.

Typical pool sizes

  • Pre seed or Seed: 8 to 12 percent
  • Series A: 10 to 15 percent
  • Series B and beyond: 8 to 12 percent, with refreshes as needed

2) Pool sizing math founders actually use

Pre vs post money pools
 Investors often ask you to create a pool before their money comes in. That means the dilution for the pool hits founders, not the new investor.

  • Target pool post money equals 10 percent
  • ⁠If the investor wants it created pre money, founders take the full 10 percent hit
  • ⁠If created post money, everyone shares dilution pro rata

Worked example
Company pre money is 10 crore, new investment 5 crore, target ESOP pool 10 percent post money.

  • Post money valuation equals 15 crore
  • ⁠Shares outstanding pre round equals 100
  • ⁠New investor owns 5 over 15 equals 33.33 percent
  • ⁠ESOP pool equals 10 percent
  • ⁠Founders end up at 56.67 percent

If the investor demands the pool be created pre money, the founders dilute to 50 percent, investor to 33.33 percent, ESOP to 16.67 percent. Same post money target, very different founder outcome. Negotiate the pool source in the term sheet.

Rule of thumb
Model three scenarios in your cap table: no pool change, post money pool top up, pre money pool top up. Decide based on the hiring plan for the next 18 to 24 months.

3) How to create an ESOP pool, step by step

The process varies by country and listing status. For Indian private companies, the high level flow is:

  1. Plan design
     Define eligibility, instrument type, vesting, cliff, exercise price, expiration, buyback and liquidity policy, treatment on termination, and governance.

  2. Board approval
     Approve the ESOP scheme and pool size. Record minutes.

  3. Shareholder approval
     Pass a special resolution with an explanatory statement. For listed companies, follow SEBI SBEB Regulations. For private companies, follow Companies Act and relevant rules.

  4. Create and maintain registers
     Maintain ESOP grant registers and grant letters. On exercise, file allotment forms and update the cap table.

  5. Valuation and pricing
     Set exercise price, usually at face value for options in India, with fair market value determined by a registered valuer or merchant banker for tax purposes at exercise. In the United States you would obtain a 409A for FMV. Keep valuations current.

  6. Communication pack
     Create an offer addendum, grant letter template, a simple calculator, and a one pager that explains vesting, cliff, tax, and liquidity.

4) Plan terms that actually work

  • Vesting. Four years with one year cliff, then monthly or quarterly thereafter.
  • Exercise price. Face value in India for private companies is common.
  • ⁠Exercise window after exit. Give at least 90 days post termination, 180 days is friendlier. Senior roles may get 12 to 24 months.
  • Leaver policy. Unvested options lapse on resignation. Vested options can be exercised within the window. For cause terminations forfeit all.
  • ⁠Acceleration. Single trigger on change of control or double trigger on change of control plus termination within 12 months, for a defined senior group.
  • Refresh grants. Annual top ups for high performers so long term employees do not end up underwater.
  • ⁠Buyback and liquidity. Define the if, when, how much, price formula, and tax handling up front.

5) How to allocate the pool across roles

Use bands rather than case by case haggling. It speeds hiring and reduces internal noise.

Sample banding for early stage

  • Senior leadership. 0.5 to 2 percent each.
  • ⁠Engineering managers or principal engineers. 0.2 to 0.5 percent.
  • ⁠Senior engineers or product managers. 0.05 to 0.2 percent.
  • ⁠Early generalists or first ten hires. 0.1 to 0.5 percent.
  • ⁠Later hires. 0.01 to 0.05 percent, with performance top ups.

Anchor grants to value creation milestones. For example, higher end of the band for roadmap owners or critical hires before product market fit.

6) Tax and valuation, the parts that trip people up

India overview for private companies.

  • At exercise. Perquisite tax applies on the difference between FMV and exercise price, treated as salary income. TDS obligations apply for the employer.
  • At sale. Capital gains tax applies on the difference between sale price and FMV at exercise.
  • ⁠FMV. Determined by a merchant banker at exercise. Keep valid reports around grant and exercise events.
  • ⁠Secondary transfers. If employees sell to an investor, tax is capital gains based on cost and holding period.
    ⁠
    ⁠Keep clean documentation. Your future diligence team will thank you.

7) How to use the ESOP pool effectively

  • Front load fewer, bigger grants for the first ten hires, then move to bands.
  • Refresh grants yearly for top performers to fight drift and compression.
  • ⁠Top up after major milestones like Series A or product market fit to retain pivotal people.
  • Avoid hoarding the pool. A pool that never leaves the spreadsheet does not hire or retain anyone.
  • ⁠Avoid spraying tiny grants that no one values. If it cannot move the needle for the person, consolidate.
  • Create an internal ESOP handbook. Explain value, vesting, tax, and your liquidity policy in simple language.

8) Budgeting and accounting. The founder view

There are two views. The statutory view and the operating view.

Statutory view
 Under Ind AS 102 or IFRS 2, ESOPs are expensed as a non cash share based payment over the vesting period, based on fair value at grant. Company buybacks are usually shown as a reduction in equity, not through the P and L.

Operating view, my recommendation for planning
 Even if buybacks do not always hit the P and L as an expense, they are a real cash outflow. Plan them like an expense line. It keeps you honest on cash runway.

Practical model to include in your P and L and cash plan

  • Line A. ESOP non cash expense per accounting.
  • Line B. Expected ESOP cash taxes or withholding the company must fund, if any.
  • ⁠Line C. Annual ESOP buyback pool, for example 1 crore or 1 percent of fully diluted value, whichever is lower.
  • ⁠Total cash impact equals B plus C. Track it like payroll.

Worked cash example

  • Annual salary burn equals 12 crore.
  • ⁠Plan a buyback once a year post round at 50 lakh.
  • ⁠Plan tax or admin cash of 10 lakh.
  • Add 60 lakh to your cash budget.
  • New annual cash burn equals 12.6 crore.
  • ⁠At 18 crore in the bank, runway falls from 18 months to around 17 months. This is real. Model it.

9) Price setting for buybacks and secondaries

Pick a simple, defensible rule. Communicate it upfront.

  • Round based. Last primary round price, possibly with a 10 to 20 percent discount for illiquidity.
  • ⁠Valuer based. Independent valuation each buyback window.
  • Hybrid. Lower of last round price and independent valuation if the market softened.

Be consistent. Your team values predictability more than a slightly higher price once.

10) Compliance checklist for Indian private companies

This is a quick list to help you brief counsel.

  • Draft ESOP scheme per Companies Act and rules.
  • ⁠Board approval and special resolution of shareholders with an explanatory statement.
  • Maintain ESOP register and grant letters.
  • ⁠Obtain FMV reports as required for tax at exercise and for buyback pricing.
  • On exercise, collect exercise price and taxes if applicable, allot shares, file PAS 3, update registers.
  • For buybacks or secondary transfers, follow company law and tax rules, obtain necessary approvals, and withhold taxes if required.
  • ⁠For non resident employees, check FEMA and FDI rules.
  • ⁠For listed companies, follow SEBI SBEB Regulations.

11) Templates you will reuse

  • ESOP policy and scheme document
  • Board and shareholder resolutions
  • Role based equity band matrix
  • Grant letter and offer addendum
  • ⁠ESOP calculator for candidates
  • ⁠Buyback policy note and FAQ
  • ⁠Annual communication pack with vesting statements

12) Common mistakes to avoid

  • Creating the pool pre money without modeling dilution.
  • Promising liquidity casually. If it is not in your policy, it does not exist.
  • Setting exercise windows that are too short. It frustrates alumni and hurts your brand.
  • ⁠Letting options expire unexercised because of poor reminders and no post exit window.
  • Treating ESOP as a negotiation prize rather than a structured program.
  • Forgetting tax and cash impact. Your runway will not forgive you.

13) How to explain ESOP to candidates in 60 seconds

  • You get options that vest over time.
  • ⁠You can buy shares at a fixed price after vesting.
  • ⁠If the company grows, your shares grow in value.
  • ⁠We run an annual buyback window after rounds so you have a path to partial liquidity.
  • ⁠Here is your grant, vesting schedule, and a calculator that shows value at different outcomes.

People do not need a lecture. They need clarity and trust.

Quick FAQs

1. How big should my first pool be
Ten percent is a solid default for Seed and Series A. Model against your hiring plan.

2. Should I grant RSUs or options
For Indian private companies, options are simpler pre listing. RSUs are more common in listed entities.

3. How often should I do buybacks
Once a year after a primary round is common. Start small, publish the rules.

4. Can I let employees sell to investors in a round
Yes, run a managed secondary with caps and disclosures.

5. What if the market drops after I grant options
Use refresh grants and future performance based top ups. Avoid repricing without a clear board policy.

6. When should I refresh my ESOP pool
Typically every 18 to 24 months or at the next funding round. Refresh earlier if your pool drops below 3 to 4 percent of fully diluted.

7. Should I give ESOPs to interns or consultants
Usually no. ESOPs are designed for long term employees. For interns or consultants, short term cash or project based incentives work better.

8. Can I accelerate vesting for key employees
Yes, but do it under a clear policy such as change of control, acquisition, or board approved exceptions. Avoid ad hoc promises.

9. What happens if an employee leaves before cliff
All options lapse. They do not get any ESOP value. Communicate this clearly upfront.

10. Should I allow employees to hold options after they resign
A 90 to 180 day exercise window is standard. Senior leadership can be given a longer window of 12 to 24 months.

11. Can ESOPs be repriced if valuations fall
It is possible but tricky. It requires board and shareholder approval and can create governance issues. Use new grants or refreshers instead.

12. How do ESOPs impact fundraising negotiations
Investors look at pool size, dilution, and unallocated stock. A clear ESOP plan signals maturity. A messy or unused pool raises red flags.

13. Do ESOPs work for remote or global hires
Yes, but check cross border tax and compliance. For non resident employees, FEMA and FDI rules in India apply. Some founders use phantom stock for simplicity.

14. What is a phantom ESOP and should I consider it
Phantom ESOPs are cash settled and mimic equity value without share issuance. They are easier legally but create cash liability. They work for late stage or subsidiaries.

15. How do I communicate ESOP value to candidates
Always show a calculator with potential outcomes at different valuations. Avoid quoting notional crore values with no context.