Equity Incentive Plans: Because Team Retention Requires More Than Free Pizza

When it makes sense to set up an Equity Incentive Plan.

Equity incentive plans ("EIPs") are legal frameworks that allow companies to grant equity-based compensation to their executives, directors, and employees. These plans are particularly valuable for startups that want to attract top talent without paying high salaries in the early stages. By giving team members a stake in the company, founders create a sense of ownership and loyalty that ties each person's success to the company's growth.

Once the initial founder equity is divided, the next step is deciding how much equity to reserve for future team members. In most cases, companies set aside between five and twenty percent of their total equity for this purpose. Typically, the board of directors is authorized to grant awards under the plan, though this authority can be delegated if necessary.

Early-stage startups often issue restricted stock or restricted stock units (RSUs). These grants involve actual shares of stock issued upfront, usually for a nominal price such as $0.001 per share. While the recipient owns the stock right away, it is subject to conditions—most commonly a vesting schedule that determines when the shares become fully owned. Many recipients file what is known as an 83(b) election with the IRS to minimize future tax burdens if the company's value increases later on.

Stock options are another common form of startup equity. Rather than issuing shares immediately, stock options give employees the right to purchase shares in the future at a set price, often referred to as the strike or exercise price. This price is typically equal to the fair market value at the time of the grant. There are two main types of stock options: incentive stock options (ISOs),which receive favorable tax treatment but can only be granted to employees, and non-qualified stock options (NSOs), which are more flexible but do not qualify for the same tax advantages.

The advantages of an EIP extend beyond compensation strategy.

The advantages of an EIP extend beyond compensation strategy. Startups can conserve cash, attract and retain skilled individuals, and align everyone's incentives toward long-term success. Having a formal plan in place also signals professionalism to investors and can help avoid future tax and compliance issues. However, EIPs are not without drawbacks. They inevitably dilute ownership, can create complex tax situations, and sometimes fail to motivate employees if vesting schedules feel too rigid or distant. Equity alone also cannot replace strong culture and management.

Equity incentive plans are best suited for startups that cannot afford to pay top-tier salaries but still need exceptional talent. They are particularly effective in roles that are difficult to fill or critical for company growth. These documents often include board and stockholder consents approving the plan, the plan itself, and form agreements for restricted stock and stock option grants.

Eligibility to participate in an EIP generally extends beyond employees to include advisors, consultants, and board members. When someone leaves the company, any unvested equity is typically forfeited and returned to the company, a process sometimes referred to as reverse vesting or repurchase rights in the case of restricted stock.

In practice, founders should adopt an EIP before granting equity to team members or third-party service providers. For companies structured as LLCs, a traditional EIP will not apply, and a phantom equity or profits-interest plan is usually more appropriate. In any case, consultation with legal and tax professionals is essential to ensure compliance and to tailor the plan to the company's long-term goals.

Written by Omar Zoubeidi, 3L at Loyola University Chicago School of Law. Omar will be sitting for the bar in July 2026. Omar is not yet licensed to practice law, and none of the information provided here should be construed as legal advice.