Startup equity is confusing by design — or at least it feels that way. But the underlying mechanics are simple once you break them down.
The cap table
A capitalisation table (cap table) is a spreadsheet that shows who owns what percentage of your company. In a freshly incorporated startup, the founders own 100%.
When you raise money, you issue new shares to investors. This dilutes everyone's percentage — but the total value of the company hopefully increases, so everyone's absolute value goes up.
Example: You own 100% of a company worth ₹50 lakh (₹5 per share, 10 lakh shares). An investor puts in ₹50 lakh at a ₹1 crore valuation. They get 33% of the company (new shares). Your 10 lakh shares are now 67% of the company. But the company is worth ₹1.5 crore, so your stake is worth ₹1 crore — double what it was before.
This is why dilution isn't inherently bad. It's about whether the value created exceeds the ownership given away.
ESOPs explained
An Employee Stock Ownership Plan (ESOP) is how you give employees a stake in the company's success. Instead of cash, they get options — the right to buy shares at a fixed price (the exercise/strike price) in the future.
Vesting: Options don't vest immediately. A typical schedule is 4 years with a 1-year cliff. The cliff means no options vest in the first year. After the cliff, 25% vests, then monthly thereafter. This protects the company from people leaving early with a large stake.
Exercise price: Usually set at fair market value at the time of grant. If the company grows, the shares become worth more than the exercise price. The employee's profit is the difference.
Tax implications in India: ESOPs are taxed as perquisites when exercised (at your income tax slab rate) and as capital gains when the shares are sold. Budget 2020 deferred the perquisite tax to the earlier of: 5 years post-exercise, when the shares are sold, or when you leave the company. This made ESOPs significantly more employee-friendly.
ESOP pool size
Most startups maintain an ESOP pool of 10-15% of fully diluted shares. VCs often ask you to top up the ESOP pool before a funding round (pre-money), which increases dilution on founders.
What founders get wrong
Too little, too late: Offering 0.1% to a senior hire who would command 0.5-1% in the market. They'll say yes but mentally they'll be looking for the next opportunity.
No communication: ESOPs are worthless if employees don't understand them. Run an ESOP 101 session. Tell people what their options would be worth at current valuation and at 5x current valuation.
Ignoring secondary: As the company grows, secondary sales (letting employees sell some vested shares before an IPO) create liquidity and loyalty. Zerodha, for example, has done meaningful secondary transactions.
Equity is a long game. Get the structure right early, communicate it well, and it becomes one of your strongest hiring and retention tools.