Top 10 mistakes to avoid when launching your ESOP

Thinking about launching an ESOP (Employee Stock Ownership Plan)? A smart move! An ESOP can be a powerful tool to attract, motivate, and retain top talent by giving employees a stake in your company’s success. But there are some common pitfalls that can undermine your efforts. To help you set up your ESOP right, we’ve put together a quick guide on the top mistakes to avoid.

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What’s an ESOP?

An ESOP (Employee Stock Ownership Plan) is an employee benefit plan that allocates equity to employees, allowing them to own a part of the company. It’s designed to attract and retain top talent by aligning their success with the company’s growth. Hiring the best people is crucial for the company’s future because you need a skilled and motivated team to grow. That’s why investors always look at your team, especially in early-stage rounds.

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What should you watch out for?

We’ve been in the business of ESOP design and implementation for years now. That’s how we collected the top 10 mistakes companies make when launching their ESOP.

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#1 Overly optimistic soft commitments

It’s only natural that founders want to reward and motivate their first employees as early as possible. But in doing so, they often make overly optimistic promises regarding grant size. This is dangerous because you risk either committing too much equity too early, or hurting your employees’ trust if you backtrack on your promises later on.

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Best practice: Commit to exact figures only once you define the exact ESOP pool size and how it should be divided among the team.

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#2 Wrong ESOP pool size

The right ESOP pool size matters. It guarantees you have enough equity to attract and retain great employees, now and in the future. If the pool is too small, it will be hard to hire the best people. If the pool is too big, you could run out of shares early and won't have enough left for future employees.

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Best practice: Work with market standard numbers. At seed, companies worldwide usually set aside 10 %. For US companies, this number usually goes up to 15 % at Series A and can go as high as 20–25 % by Series D.

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#3 Lack of future-proof allocation

ESOP is a marathon, not a sprint. If you adopt a systematic approach to dividing your ESOP pool from the get-go, taking into account key company milestones and hiring needs, you minimize future mishaps. For instance, founders often give too much equity to early employees, which limits their ability to hire top talent later on without giving up more stock.

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Best practice: Create a future-focused ESOP allocation framework. Consider your current employee base as well as future hires, plan based on key company milestones and leave a buffer for unexpected situations. Need a hand? Try our ESOP allocation calculator.

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#4 Non-standard ESOP plans

ESOP is definitely not a one-size-fits all kind of thing, but it’s also not rocket science. Founders often think their company has unique needs that require unique ESOP solution. The truth is, market-standard ESOP plans do the best job because they’re tried, tested, and competitive. Fun fact: over 80% of our customers use our standard ESOP plans.

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Best practice: Start with a market-standard ESOP with battle-tested parameters and adjust only if really necessary. This will make adoption and management much easier.

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#5 Unclear cash-out moment

ESOP is all about delayed gratification. If you want it to work, your employees need to understand when they’ll see its financial benefits. That’s why you need to be clear about the exact cash-out moment. If the employees don’t see a clear path to liquidity, their motivation will suffer.

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Best practice: Most ESOP plans work with obligatory cash-out on exit. If an exit isn’t in sight, you might want to consider partial pay-out when the employee leaves or when new funds come in.

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#6 Broad Bad Leaver definition

Bad Leaver is a standard provision in all ESOP plans. It defines what happens to a leaver’s shares if they part ways with the company on bad terms - Bad Leavers typically lose all assets. Some businesses use a broad Bad Leaver definition, including the act of simply leaving the company. This may hurt employees’ trust in the program.

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Best practice: Limit the Bad Leaver clause to the most objective and serious forms of misconduct, like compromising the company’s IP, committing a crime, or breaking a non-compete clause. Resist the urge to include scenarios that are too subjective or vague.

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#7 Under-communication

Communication is everything. ESOP will only do its job if employees understand how it works. Many companies underestimate this factor, opting for a “silent launch” instead. This strategy is especially risky in countries where ESOP isn’t as widely used as in the US.

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Best practice: Overcommunicate. Before the launch, explain why the company is adopting an ESOP and its benefits. Have one-on-one sessions with employees to discuss ESOP pool allocation. Create an ESOP-pedia with key information accessible to your employees at any time. Fancy a template? Download our presentation.

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#8 Not communicating through value

Treat your employees like investors. If employees don’t understand the value behind ESOP, it’ll be tough to keep them motivated. Founders often communicate grant size through percentage instead of actual value. This misses an opportunity to position ESOP as a tool that can deliver real financial results.

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Best practice: Once again, communication is key. Regularly update your employees on the value of their ESOP portfolio. Consider using an ESOP management platform to visualize how their stock value evolves over time. Need help with that? Try a demo of our platform.

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#9 Overlooking employee taxation

If there’s one thing we learned, it’s that ESOP is 10 % law and 90 % taxes. After all, the final payout depends on how favorable (or unfavorable) the taxation regime of your employees’ country of residence is. If you look into this factor early enough, you have a higher chance of running a successful ESOP.

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Best practice: Look into the tax rules of your employees’ country of residence. As your company grows, consider offering tax assistance as a company benefit.

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#10 Ignoring company tax obligations

It’s not just about employee taxes – companies have tax responsibilities as well. In some countries, businesses are required to take extra steps, such as withholding taxes when stock options are exercised. A common mistake is that companies don’t handle this on time - and the fixes are often difficult and costly.

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Best practice: Research the tax obligations for your ESOP before adoption. Update whenever you expand to a new country or hire people in a new location.

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In a nutshell

Launching an ESOP can be a powerful tool for attracting and retaining talent, but it comes with challenges. From setting the right pool size to ensuring clear communication and understanding taxation, this guide highlights the top 10 common mistakes companies make when implementing their ESOPs. Each mistake is paired with practical advice to help you avoid pitfalls and create a successful, motivating ESOP for your team. Good luck, and if you run into any challenges, feel free to book a call with us–we’d be happy to assist you!

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