Our fifth instalment of the Pre-IPO Guide to ESOPs focuses on a critical lever - setting the right exercise price!

Exercise price does not just determine employee gains. It also impacts dilution, the income statement charge, and most importantly, signals intent - to both investors and employees. A price close to fair market value signals to investors that the company is conscious of shareholder alignment through its ESOP strategy. A deeper discount, on the other hand, may be seen as more employee-friendly, reinforcing retention and reward, but may require stronger justification depending on the company’s stage and upcoming IPO plans.

It is important to view exercise price in the context of the grant’s objective i.e., whether it is meant to reward the founding team for past efforts or to incentivize senior leadership brought in to drive IPO readiness. The key lies in striking the right balance.

Here are the three key considerations in getting the exercise price right:

Founding Team (Rewarding past contribution)
  • - First-time grants should be priced at face value or deep discount to reflect value already created.
  • - Ensure meaningful upside for early contributors who built the company’s foundation.
Leadership & Key Hires
(Driving future value creation)
  • - Moderate discount (20 to 30%) keeps options valuable while creating incentive to drive growth to gain from ESOPs.
  • - Ideal for CXOs or senior hires brought in to lead IPO or scale-up efforts.
Dilution & P&L Impact
(Balancing financial outcomes)
  • - Grant size, price, and timing must be aligned to manage dilution ahead of listing.
  • - All else being equal, a higher discount will increase the income statement charge under IND AS 102, but if used smartly, may help limit dilution by optimizing grant size.

The exercise price should reflect both the intent behind the grant and the message you want to send i.e., aligning stakeholders while supporting employee motivation and IPO readiness.

Should you have any comments or thoughts or feedback, please feel free to share write to us. We would love to hear from you!

Vichitra Malhotra, FIAI

Founder and Consulting Actuary

v.malhotra@veritas-india.com

+91-9372876627

 

Disclaimer: The above content has been furnished solely for information and must not be reproduced or redistributed. It should be noted that we are not soliciting any action based upon it. Also, it does not constitute any recommendation. In particular, the information above is for general purposes only and is not an advice on employee stock option solutions valuations or preference of one scheme over another. The information given above is in summary form and does not purport to be complete. We have reviewed the above and in so far as it includes information or facts, it is believed to be reliable though its accuracy or completeness cannot be guaranteed.