Doing an ESOP as a startup would be weird. You'd be buying common stock (?) at the valuation for cash (?), which would really complicate things. If you were a seed stage company, $20k in common stock could actually be >99% of the company (!!!). It might be a cute way to let someone buy $1.00 or so in stock inside his 401k (0.1%?) and then $19999 worth of S&P500. If it's post-A or post-B it would be a lot more sane, but still $20k might be a lot. If I were an engineer with 0.1% of a company hired at a midway-between-A-and-B company, and I could get $20k in free money, I might put $5k into buying extra company stock if that got me 0.3%, particularly since it would let me sell it and use the gains to invest tax-deferred for the next ~40 years.
There is an utterly batshit insane thing called a "Rollover As Business Startups" where you roll your own 401k over into a 401k in your newly-formed business which then buys its own stock and use that to capitalize your business. This basically lets you 1) use your 401k as capital when you can't raise (useful for franchises and traditional small businesses) 2) tax advantages. The IRS hates it, although it's fundamentally legal; they go after it on nitpicking detail compliance, which people often screw up. It's about $50-100k in 401k balance before it makes sense to do, since plan costs are about $10k to set up. I thought you could do it with Roth 401k, but it appears you may not be able to (if that could be done, it would be amazing.)
I'm also not a lawyer, but I think you wouldn't be able to make an ESOP for a startup. The value of the stock which you buy from the pool is determined by an outside auditor that evaluated the company. My guess is that startups are too volatile to evaluate and simply no one would do it.
Also, the ESOP I work for doesn't have the 401k invest back into itself. lol. That sounds super shady. It's a normal 401k through a 3rd party company, where you choose to invest in different funds. I don't really touch it and just keep it in the default fund b/c I see the whole things as gambling.
Does your company's 401k have matching, or is it just there for you to invest your own money? I worked at a place much like the one you describe and they did zero 401k match, just the ESOP, which is much as you describe with the outside auditors but still super sketchy in my opinion. If you don't do a 401k match but you do provide ESOP, then the only retirement benefit you actually provide is ESOP, which is frankly really shitty since it encourages your employees to make bad decisions. And outside auditor or not, a private company with no investors means the stock's value is, if anything, even more fictitious than a startup's valuation.
I think the equivalent of 5% of your salary is put to buying ESOP stock from a pool (I'm not entirely clear how the pool works exactly)
Then separately an amount equivalent to about 20% of your salary is put by the company into a 401k which is vested after working there for two years. There is NO matching or anything. You don't put any of your money into the 401k.
The exact 401k percentage is based on that year's profits, so it allows the company some flexibility financially speaking. If we have a bad year then you get less in your 401k, but your base salary stays the same. If it gets really really bad then people's salaries get cut (that's happened only twice in the company's ~30 history)
Bonuses, dividends and ISOP [incentive stock options plan] shares (these are actual voting shares) are also handed out partly based on yearly profits.
The whole company operates on different contracts and the market is pretty volatile (I rather not say which one, but maybe you can guess), so the system allows a measure of stability for everyone involved.
I'm not sure what the benefit of making bad decisions would be.. maybe you can elaborate on that?
Career people that have been with us for 20+ years have huge amounts of capital tied up in ISOP and ESOP shares (as well as massive 401k's) and they effectively run the company. They often retire kinda early because they are making more from dividends than from their salaries. While I really love the system and I think it's significantly better than the other currently used systems in the tech industry (which are frankly outdated), the way old careerists run the show is rather anachronistic and I think hurts the company in a lot of ways. New hires don't feel as vested in the company and the most dynamic/in-demand people at the company are probably not the people that end up staying for 20 years. I mean in SV working for more than 4 years at one company is considered the signs of a bad programmer! However, on the other hand the old-timers are the people with the most experience and that really shows at certain times.... At the end of the day I get paid well and the organization is super flat (in a ~100 employees org I'm two levels down from the CEO)
Having a 401k that's around 20% of base (on top of base I assume) is a decent benefit. I've just seen ESOP used in lieu of any employee-sponsored 401k benefit at all, i.e. only used as an option to deduct from your payroll into it.
For the individual employee, it's a very bad idea to have a significant chunk of retirement savings in your employer's stock. If your employer takes a turn for the worse, your job and your nest egg are both in jeopardy. So I would be skeptical of any stock benefits that don't allow the employee to immediately[1] sell stock and reinvest elsewhere. If it's granted on top of a proper retirement package and the main benefits are profit sharing and shareholder rights, that's fine. If its used in lieu of any real retirement benefit that's a problem.
[1] "Immediately" being relative. Some companies have insider trading policies that restrict you to trading windows, but that's an unavoidable and separate issue.
There is an utterly batshit insane thing called a "Rollover As Business Startups" where you roll your own 401k over into a 401k in your newly-formed business which then buys its own stock and use that to capitalize your business. This basically lets you 1) use your 401k as capital when you can't raise (useful for franchises and traditional small businesses) 2) tax advantages. The IRS hates it, although it's fundamentally legal; they go after it on nitpicking detail compliance, which people often screw up. It's about $50-100k in 401k balance before it makes sense to do, since plan costs are about $10k to set up. I thought you could do it with Roth 401k, but it appears you may not be able to (if that could be done, it would be amazing.)
(IANAL/IANATL/IANATA)