How To Create Incentives For Early Startup Employees Through Official Liquidity Programs

An ESO transaction can provide employees with discretionary cashVenture-backed startups rely heavily on employee stock options to attract and retain top talent. Stock options give the employees a piece of the company's upside, letting them benefit with the company's success. However, the current environment for IPOs often makes for a very long time horizon to achieve liquidity and has given rise to secondary markets for private company stock. Rather than having your employees distracted by searching for buyers of their shares and sharing confidential information with strangers, private companies should consider a private liquidity program.

In a company sponsored liquidity program, the company allows a third-party such as the Employee Stock Option Fund to provide cash liquidity to their employees. This means that confidential company due diligence is provided to only a single external entity under NDA rather than risking the outcome from numerous employees individually pursuing their own deals. The use of an ESO advance provides liquidity to employees on a low risk and tax efficient basis while not introducing any outside shareholders to the company's capitalization table. Unlike secondary market stock sales where strangers and possibly competitors get access to control and information rights, a liquidity program through ESO does not extend any management or information privileges to the ESO Fund. An ESO transaction can provide employees with discretionary cash while simultaneously preserving the employee's upside potential and thereby maintaining their loyalty to the company's ultimate success.

In addition to liquidity advances involving shares owned by employees, ESO can advance the funds to cover exercise costs. Employees benefit in numerous ways from exercising such as starting the clock on long term capital gains and avoiding heavy AMT tax consequences that can occur later if the company's stock rises in value. However, the cost of exercising can be beyond the reach of many employees. Moreover, the AMT tax triggered by the company's IRS Form 3921 filing can dramatically increase the cost of exercising. Companies therefore face a conundrum. On the one hand, they want to incentivize the employee by granting them options. But on the other hand, circumstances that prevent the employee from exercising can cripple these incentives. Owning common shares in the company gives existing employees a current stake in the business which can be a significant motivating factor.

The Employee Stock Option Fund provides financing for option exercise and for liquidity based on issued shares. No payments are due unless and until there is a liquidity event involving the company that issued the shares, such as a sale or IPO. At that time, the owner of the stock and ESO share the upside of the liquidity event and ESO is repaid. Please contact us if you'd like to learn more.