What are your ESOPs worth, if any?

Make an informed decision on the value of your ESOP grant

You look at your current compensation and remember what the recruiter told you, "Your total compensation, including ESOPs, is <so and so...>". It sounds like a nice bump from your cash component. But you still feel you're underpaid. Sigh. They are wrong. You are right. 👊🏼

It's because ESOPs are different. Say, from RSUs of public companies. RSUs are cash and should be considered part of your investment portfolio, but this post isn't about them.

ESOPs are different and complex.

The most reductive form of ESOPs is skin-in-the-game + participation in business upside. An employee accepts below-market compensation to be fully vested in the startup's outcomes. An employer offers ESOPs because it cannot pay its talented team the same as Netflix does.

Consider this. If, as a "Tech Lead" in India, your cash compensation is 40 LPA, and you are given 1Cr worth of ESOPs for 4 years, that does not make your total compensation 65LPA (40 + 100/4). Nope. ESOPs convert to cash in hand only when a liquidity event happens. But I am getting ahead of myself. More on liquidity later. Let's first see if and when that liquidity event happens; how much are your stock options worth?

Tangible: numerical value, and intangible: likelihood of success

ESOPs are evaluated in two parts: 1️⃣ The numerical value when you "make bank" and 2️⃣ The likelihood of you making bank. Let's discuss 1️⃣ first. We will need a few numbers. These are important; without those, no bueno.

1. Current company valuation — C. Say, the company was $200M when you joined.

2. A marquee or future valuation (such as $1B, the 🦄) — M (best to pick a valuation 4 years down the line when your ESOPs fully vest)

3. What is the current % of your grant of the total valuation? Let's call it P. This is important for a couple of reasons. First, number of stocks and stock value differs from company to company. Percentage lets you compare with market standards. Secondly, % can reveal room for growth. If you look only at $ value, there's no way of knowing if and how much more the company can grant you. With percentages, you can look at benchmarks and get a fair idea. Remember that you're trying to determine a future value today and not trying to create a tracking system. It bears repeating that equity does not translate to cash in a private company like in a public company.

4. Lastly, let’s ignore the strike price. In early-stage companies (Seed, A, B rounds), strike prices are usually $1 or $10—not high enough to matter. If it is high enough to matter, something is off.

C & P are precise. M is hypothetical, based on a prediction. M/C is the multiple that will decide the maximum value for your ESOPs. Basic Maths will tell you that 1Cr ESOPs will be worth 1 Cr * M/C when the company reaches the valuation M.

But remember that P will dilute when C reaches M. If you own 1% today, you won't always own 1%. It will go down and down with each funding cycle. How much down? That usually depends on how much capital is raised. The more you raise, the more you dilute. What kind of businesses raise a lot? Marketplaces, Ride-hailing, and Consumer businesses are typical examples. B2B SaaS startups, on the other hand, raise fewer dollars because they can make money early in their lifecycle.

Dilution is the hidden factor.

Back to numbers. C, M, P, and M/C your dilution evaluation. By linear logic, the value of your fully vested ESOPs is P * M/C. But every time you raise capital, you must make space for new investors on the cap table. That means the total value of the stock goes up, but the % value goes down for everyone currently on the cap table. You're not on the cap table, but your ESOPs are part of the pool on the cap table.

Let's consider various scenarios for dilution.

0%: The company did not raise any additional capital. If M is big, this is a great scenario, which is unlikely but great.

20%: Because of ace founders. They run a great business and are savvy negotiators.

30-40%: Median; the usual case

50%-70%: Capital-heavy business or poor negotiations.

70-100%: You drew the short straw. Bad luck.

Jeff Bezos owns ~9% of Amazon, Elon Musk owns ~20% of Tesla, and Parker Conrad, the wizard founder of Rippling, allegedly owns 22%. They all owned more than 75% at some point.

So, what does the numeric value come to?

Let's say the ₹1Cr ($120k) grant was worth 0.1%, putting C at $120M. And the company will be a unicorn in 4 years, so M is at $1B. Your ESOPs are worth

(1 - 0.5) * 0.1 * $1B = $500k # at a 50% dilution 

and

(1 - 0.2) * 0.1 * $1B = $800k # at a 20% dilution

Don't limit yourself to these two figures; put them in a spreadsheet and simulate various scenarios. If you want a copy of the spreadsheet I use to run simulations, drop a comment.

In the next post, we will address 2️⃣, the likelihood of actually making money from ESOPs. It depends on the probability of your startup succeeding enough to have a liquidity event and the quality of the ESOP offer in terms of exercise window, vesting schedule, and other critical factors.

Happy hacking!