A good time not a long time – why it’s critical to get your ESOP right
Talent attraction and retention are two of the biggest hurdles Australian founders are facing on the start-up journey. One method that my guest puts forward, in the latest episode of Platform Diaries, is establishing Employee Share Option Plans (ESOPs). A somewhat complex legal arrangement, an ESOP scheme can be expensive to set up, take time to understand and careful thought and planning to be effective.
Alright, I know what you’re thinking. As a busy founder juggling multiple roles, with a thousand tasks on the to-do list, adding something like an ESOP may feel best suited for the ‘too hard’ basket.
But Steve Grace - the founder of The Nudge Group, an Antler Angel who invests in numerous businesses, CEO of publication Balance the Grind, director at YBF Ventures, and last week’s Platform Diaries guest - argues the benefits outweigh the drawbacks.
During last week’s episode, we discussed the challenges of team transformation during the start-up to scale up phase. This week, we’re nutting out how founders can attract the right people from the outset to go on the start-up journey with them. Whilst we don’t suggest you use this week’s episode in place of legitimate financial or legal advice from a professional, we do want to demystify the process and share the point of view from a founder who has done it before.
Steve shares that ESOPs are, “a way of giving your staff a share in the business to ensure that they will be rewarded. No, they are not all the same. There’s a number of ways they can be rewarded. There are dividends out of a business when they later become profitable, there are profits if the company is to be sold at trade sale or partly sold, there is potential for people to buy out other shares from other investors at a later stage, and there's also obviously floating a business and then taking it to an IPO."
These ESOP schemes vary due to the variation of liquidity events. Put simply, a liquidity event that allows people to cash out some or all of their ownership shares.
I empathise if you’re feeling slightly overwhelmed. However, at its core, an ESOP benefits a founder by offering a lower wage with the promise of future reward and ensures that your employees have skin in the game, because the businesses’ success will directly translate to their financial success.
“ESOPs have become very popular here in Australia in the last two/three years. Prior to that, there weren't that many. Everyone’s heard the stories of the Facebook early employees and the Google early employees, and even the Canva and SafetyCulture early employees, but first up, ESOPS are not all the same. There is a trend of the way that they look at the moment, but actually an ESOP plan can be designed absolutely any way you want, and every single one is probably different to some degree, unless you’ve come through some sort of incubator where you're using a template.”
Back in 2020, SafetyCulture made headlines for seeing their staff and investors cash in on a $48.5m round. Canva’s remarkable success using ESOPs is one of the reasons they attract 300,000 job applications a year. While these success stories represent one version of ESOP success, Steve argues that these are not the only ways to go about them.
“I’ve seen them go very well, and I wouldn’t necessarily say I’ve seen them go very wrong, but there are a lot of cases where if you don't stay with that business until whatever that liquidity event is, you lose your shares. If you lose your shares or your options, then you've taken a lower salary for no benefit at all, which is madness,” Steve said.
Steve thinks that one of the main aspects of creating an effective ESOP plan for both parties is open communication and dialogue. Determining whether your employee believes they’ll be there until the very end, or whether they are there for a good time and not a long time should significantly change the type of plan constructed.
“I just don't think there's enough information and education out there around use of plans, or for people to really understand how to use them effectively, or employees to understand what their real value is,” Steve said.
Gold-coast startup Cake Equity is one of the first businesses to attempt to fulfill this knowledge demand, however Steve believes they aren’t quite where they need to be yet.
“They do what they do well, but it only works for box standard ESOPs because the complexity is too great. The only way to do it is with a lawyer, and unfortunately, it's not cheap to set one up, but then most good things really aren't cheap. I think the problem is people take these box standard ones and think they are fit for purpose,” Steve acknowledges.
His advice for founders looking into ESOPs is to invest the money to set up the foundations at the beginning or the startup journey, and to ensure within your plan there are lots of options because you don’t know what is going to happen in the future.
“I think there's nothing more demotivating for employees who take a lower salary for an ESOP, where there's no planned exit for ten years, and they don't want to work there for ten years.”
Steve is currently on his third startup journey where he has incorporated an ESOP. His advice to his previous self is to take the time to fully understand what an ESOP is and what it can do for his business and invest the time and resources into a lawyer that can create a flexible plan that aligns with what he wants to achieve.
If you’re a founder that is interested in establishing an ESOP but are still unsure of the best place to start, you can find Steve Grave at Nudge Group, a growth consultancy group that helps founders go from startup to Unicorn.