Five key Steps to Successfully Setting Up an ESP for private companies

Written by Dan Coyle and Hunter Sattich

Private companies are continuously looking for innovative ways to attract, retain, and engage top talent. An Employee Stock Plan (ESP) can be a powerful tool to achieve these goals, but setting one up requires careful planning and expert guidance. Unlike public companies, private firms often lack access to the same level of sophisticated service and strategic support when structuring equity plans—yet their needs are just as critical.

To maximize the benefits and avoid potential pitfalls, directors and boards of private companies must take a strategic and well-informed approach. Here are five essential steps to setting up an ESP that works for your company and employees.

1. Build a Strong Foundation: Understand Equity Compensation Options

Before implementing an ESP, it’s essential to grasp the broader landscape of equity compensation and determine how an ESP fits within it. Equity compensation involves giving employees an ownership stake in the company, aligning their success with the company's performance. This can be particularly valuable for private firms that may not have the cash flow to offer top-tier salaries but still need to attract and retain talent.

Key Equity Compensation Structures:

• Stock Options: Employees gain the right to purchase shares at a fixed price in the future.
• Restricted Stock & RSUs: Shares are granted with vesting conditions that must be met before full ownership.
• Phantom Stock: A deferred compensation model that pays out based on stock value, without transferring actual ownership.
• Stock Appreciation Rights (SARs): Employees receive payouts based on stock price appreciation.
• Direct Stock Grants: Shares are awarded outright, without restrictions.

Knowing the strengths and implications of each model allows private companies to make informed decisions and create an ESP structure that aligns with business objectives and long-term growth strategies.

2. Assess Whether an ESP is the Right Fit for Your Business

Not every company is suited for an ESP. Before moving forward, leadership must evaluate key factors such as financial stability, ownership structure, and long-term business goals.

An ESP can be particularly beneficial for companies looking to:
✔ Incentivize Employees: Encouraging a culture of ownership and long-term commitment.
✔ Attract & Retain Talent: Providing a competitive compensation package when cash resources are limited.
✔ Plan for Long-term Success:. – Focus on long-term profits/benefits
ESPs can align your company’s interests with the interests of your employees over a long period. They’re not only trying to hit targets for this year, but also moving the company forward to sustain its growth in the long run.

A well-structured ESP can drive employee engagement and position a company for sustained growth—but only if it aligns with the company’s operational and financial realities.

3. Get Ahead of Legal, Tax, and Financial Complexities

ESPs come with significant legal, tax, and financial considerations, and navigating these complexities requires expert support. Unlike a simple bonus structure, an ESP must comply with securities laws, tax regulations, and valuation requirements.

🔹 Securities Compliance: Issuing equity to employees requires adherence to regulations to avoid penalties and liabilities.
🔹 Valuation Requirements: Establishing a fair market value is critical to avoid tax and compliance issues—this often necessitates a 409A valuation.
🔹 Tax Considerations: ESPs can offer tax advantages, but structuring them incorrectly can create liabilities for both the company and employees.

The level of expertise required to set up an ESP is similar to what companies need when going public. Seeking guidance from legal, financial, and tax professionals is crucial to designing a plan that maximizes benefits while mitigating risks. This can help prepare companies that are preparing for an Initial Public Offering(IPO) of stock in the future.

4. Protect Your Shareholders: Address Potential Dilution

One of the most significant concerns when issuing employee equity is share dilution. Introducing an ESP means redistributing ownership, which can impact decision-making power and shareholder value.

Before finalizing an ESP, companies should:
✔ Evaluate Ownership Impact: Determine how ESP shares will affect existing stakeholders.
✔ Set a Thoughtful Allocation Strategy: Balance the need to reward employees with maintaining shareholder interests.
✔ Communicate Transparently: Address dilution concerns proactively with current investors and leadership teams.

A well-managed ESP should strengthen company value over time, ensuring that both employees and shareholders benefit from its long-term success.

5. Set Employees Up for Success: Communicate & Educate

Even the best-designed ESP won’t succeed if employees don’t understand it. A key factor in making an ESP effective is ongoing education and clear communication.

Companies should ensure that employees know:
- How the ESP Works: Provide simple, straightforward explanations of vesting, ownership, and potential financial impact.
- The Benefits & Risks: Help employees understand how their shares align with the company’s growth.
- Their Role in Value Creation: Reinforce that their contributions directly impact the company’s performance—and their own equity value.

Providing continuous education and ensuring transparency fosters trust, engagement, and a shared sense of ownership, which in turn drives long-term success.

Making Your ESP a Strategic Advantage

Setting up an ESP can be a transformative decision for a private company, but it requires careful planning and expert execution. By understanding the full scope of equity compensation, evaluating company readiness, navigating legal and financial complexities, protecting shareholder interests, and ensuring employee education, private companies can create an ESP that drives engagement, retains talent, and fosters long-term value creation.

Just as companies going public rely on comprehensive support, private companies should seek expert guidance to navigate the intricacies of setting up an ESP. Taking these steps ensures that an ESP is not just an employee perk—but a strategic advantage that fuels company success.

Disclaimer:

The information provided here is for general informational purposes only and should not be construed as professional tax advice. Tax laws and regulations are complex and subject to change. For personalized advice tailored to your specific situation, it is always recommended to consult a qualified tax professional or accountant who can provide expert guidance based on your individual circumstances.

To learn more about our Stock Plan Service Division, please visit https://www.siebert.com/sps.

For any Stock Plan Service inquiries, please reach out to our Siebert.SPS Team.
Dcoyle@siebert.com
Hsattich@siebert.com