Article · Startup Advisory & Formation
ESOP structuring: five questions founders answer too late
An option pool is a capital structure decision, an employment decision and a tax decision at once. Most schemes are drafted as though it were only the first.
7 min read
Employee stock option schemes are usually adopted in the week before a funding round, using a template, with the pool size set by the investor. Each of the questions below becomes materially more expensive to answer after grants have been made.
1. What happens on an exit, and who decides?
Whether unvested options accelerate on a change of control, and whether acceleration is single or double trigger, determines the negotiating position of the management team in an acquisition. Silence on the point means the acquirer decides.
2. What happens to a good leaver?
A scheme that permits exercise only while in employment, with a short post-termination window and no liquidity event in sight, is not an incentive. It is a retention device that employees eventually recognise as such.
3. Who bears the tax, and when does it fall?
The point at which tax is triggered - grant, vest, exercise, or sale - shapes whether an employee can afford to exercise at all. A scheme requiring cash at exercise, years before any liquidity, transfers the risk of the company's success to the employee.
4. How is fair value determined?
The valuation methodology should be stated in the scheme rather than settled at each exercise. A methodology chosen after the fact is a source of dispute in every direction.
5. Does the cap table reflect reality?
Options granted, options vested, options exercised and the unallocated pool are four different numbers. Boards routinely quote one of them as though it were all four.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. Boards should consult qualified legal counsel for company-specific guidance.