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Legal
When you are building a startup, the people around you matter a lot. The early team is often taking a bet on the business too. They are joining before everything is proven, before the structure is perfect, and often before you can offer the same salary or certainty as a larger company.
An Employee Share Option Plan, or ESOP, is one way to recognise that. It gives employees the option to buy shares in the company in the future, usually at a set price and once certain conditions have been met. If the company grows in value, those options can become valuable too.
For founders, an ESOP can help attract great people, retain key team members and give employees a real connection to the company they are helping to build.
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What is an ESOP?
An ESOP is a plan that gives eligible employees, advisors or key contributors the right to buy shares in the company later. They are not usually receiving shares straight away. Instead, they receive options.
Those options usually have an exercise price, which is the price the person would pay if they choose to exercise the option in the future. If the company’s value increases over time, the employee may be able to benefit from the difference between the exercise price and the value of the shares.
That is the simple idea. The person helps build the business, and if the business grows, they may share in the upside.
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Why startups use ESOPs
Startups use ESOPs because hiring great people is hard, and keeping them can be even harder.
An ESOP can help you offer something more meaningful than salary alone. It gives employees a reason to think longer term and feel more invested in the company’s success.
It can be especially useful when you are hiring early employees, senior leaders or people who are taking on more risk by joining the business at an earlier stage.
A well-designed ESOP can help you:
- attract strong candidates
- retain key people
- reward early employees for taking on startup risk
- build a stronger ownership culture
- align the team around long-term growth
- manage cash while still offering meaningful upside
But it needs to be structured properly. Equity is valuable, and it should be offered with care.
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How ESOPs usually work
Most ESOPs start with the company setting aside a pool of equity for employee incentives. This is often called an ESOP pool or option pool.
From there, options can be granted to eligible people. Those options usually vest over time. Vesting means the person earns the right to exercise their options gradually, instead of receiving everything upfront.
For example, someone might receive options that vest over four years. That structure helps reward people who stay with the business and contribute over time.
Once options have vested, the person may be able to exercise them by paying the agreed exercise price. If they do, they become a shareholder.
The details can vary, which is why the plan needs to be clear from the beginning.
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What founders should think about before setting up an ESOP
An ESOP is more than a template document.
Before setting one up, founders should think about how the plan will work in practice.
That includes:
- who should be eligible
- how large the ESOP pool should be
- how much equity should be offered for different roles
- when options should vest
- what happens if someone leaves
- how the ESOP affects the cap table
- what happens in a sale or exit
- how the plan will be explained to employees
- what the tax and accounting implications are
These details matter because ESOPs can become messy if they are rushed.
A quick verbal promise like “we’ll give you equity” can create confusion later if it is not properly documented. That becomes even more important before a capital raise, when investors may review your cap table, employee arrangements and option grants.
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Make sure people understand what they are getting
An ESOP only works if people understand it.
Employees should know what options are, how vesting works, what the exercise price means, and what might happen if they leave or if the company is sold.
They should also understand that options are not the same as cash. The value depends on what happens to the company in the future.
Clear communication helps avoid disappointment and builds trust. It also makes the ESOP more meaningful, because people can actually understand the opportunity in front of them.
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Build the plan before you make the promise
Equity promises can feel simple in the early days, especially when the team is small and everyone is moving quickly.
But as the business grows, those promises need proper structure behind them.
A clear ESOP gives everyone more certainty. Founders know what has been offered. Employees know what they have received. Investors can see how the plan fits into the company’s cap table and growth plans.
It is much easier to set this up properly at the start than to untangle it later.
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How LUNA can help
An ESOP sits across legal, tax, accounting and commercial strategy, so it helps to get the right advice early.
At LUNA, we help startups and scaleups design and implement ESOPs that make sense for their stage of growth.
That can include support with the ESOP structure, plan rules, employee communications, tax considerations and ongoing administration.
The goal is to create a plan that is clear, practical and easy to explain to your team, your board and future investors.
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FAQs
What does ESOP stand for?
ESOP usually stands for Employee Share Option Plan or Employee Stock Option Plan. In Australia, it is commonly used to describe a plan that gives employees or other eligible participants the option to acquire shares in a company in the future.
Is an ESOP the same as giving employees shares?
No. Under an ESOP, employees are usually granted options rather than shares upfront. An option gives them the right to buy shares later, usually once vesting conditions have been met.
What is vesting?
Vesting is the process where an employee earns the right to exercise their options over time. It helps encourage people to stay with the company and contribute to its growth.
When should a startup set up an ESOP?
Many startups set up an ESOP when they are hiring key employees, preparing for a funding round or formalising equity arrangements. It is usually better to set up the plan before making informal equity promises.
Do founders need advice before setting up an ESOP?
Yes. ESOPs can involve legal, tax and accounting considerations, so it is worth getting advice before putting a plan in place or offering options to employees.
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