Incentive Plans for Growing Private Companies: A Comprehensive Guide

Incentive plans are among the most powerful tools a private company can use to drive performance, retain key employees, and align team efforts with long-term business goals. While public companies have long relied on stock options and performance bonuses to attract and motivate talent, private companies often assume these strategies are out of reach. The reality is quite the opposite.

In fact, incentive plans are especially important for private companies. Without the visibility, liquidity, and valuation metrics of public markets, private firms must be more intentional in how they reward and retain talent. Whether your company plans to remain private, go public, or prepare for acquisition, a well-designed incentive strategy can create powerful alignment between employees and owners, without relying solely on salary increases or traditional perks.

By designing an effective incentive plan, private companies can:

• Motivate employees to achieve short- and long-term goals
• Retain top talent through meaningful rewards that vest over time
• Compete for high-performing candidates even without the highest salaries
• Link compensation directly to company performance and success
• Foster a sense of ownership and accountability across teams

A good incentive plan isn’t just about giving people more money—it’s about designing systems that make every employee feel personally invested in the company’s future.

The Business Case for Incentive Plans in Scaling Companies

As companies grow from startup to scaleup, the complexity of managing performance, retaining top talent, and aligning efforts across departments increases dramatically. Salaries alone are often not enough to keep employees motivated through this journey, especially when they could find more lucrative compensation packages elsewhere.

Incentive plans bridge this gap by making employees participants in the company’s value creation. They encourage employees to think and act like owners, prioritize outcomes that matter most, and stay committed through periods of uncertainty and rapid growth.

This is particularly important in private companies where:

• Cash flow may be tight
• The value of equity isn’t obvious to new hires
• The company’s future direction is still evolving
• Formalized career paths are still being built

In these environments, smart incentives can substitute for structure and predictability, offering motivation where traditional tools fall short.

Short-Term Incentives: Structuring Effective Bonus Plans

Short-term incentive plans (STIPs), often paid as cash bonuses, are the most immediate and flexible way to reward performance. They’re ideal for motivating results on a quarterly or annual basis and can be tailored to individual, team, or company-wide outcomes.

Individual Performance Bonuses

These bonuses are tied to specific metrics that measure personal performance. They work well for roles with clear output—like sales, account management, or operations—where individual results are easily measured.

Example:
A sales representative is eligible for a quarterly bonus based on revenue closed. They receive a 10% bonus if they hit their target, 15% if they exceed it by 20%, and 20% if they exceed it by 40%.

Best practices:

• Set clear, achievable performance metrics
• Use tiered bonus levels to encourage overperformance
• Make payouts predictable and consistent to reinforce motivation

Team-Based Bonuses

These bonuses reward cross-functional groups or departments that meet collective objectives. They’re useful for encouraging collaboration and breaking down silos.

Example:
A product and engineering team is given a shared goal to ship a new feature by a specific deadline. If successful, the team splits a bonus pool based on individual contributions or equally.

Best practices:

• Define team goals in advance and tie them to business outcomes
• Ensure shared responsibility among all team members
• Use manager feedback or 360-reviews to determine distribution

Company-Wide Bonuses

These are broad-based incentives paid when the company achieves significant milestones—like hitting revenue targets, launching a new product line, or reaching profitability.

Example:
If the company reaches $10 million in ARR by year-end, all full-time employees receive a 5% annual bonus.

Best practices:

• Use company-wide bonuses to build unity and shared accountability
• Clearly communicate progress toward goals throughout the year
• Avoid offering these too frequently—make them special and tied to real achievement

Designing Bonus Plans That Drive Results

While bonuses are relatively simple to implement, they can fail to motivate if not designed thoughtfully. Here’s how to make sure your bonus plan supports your company’s objectives:

• Align incentives with strategic priorities: Choose KPIs that truly matter to your company’s success—not vanity metrics.
• Set targets that are challenging but achievable: Stretch goals work best when employees feel they have the tools to succeed.
• Balance individual and collective rewards: A blend of personal, team, and company bonuses can avoid unhealthy competition or siloed thinking.
• Communicate early and often: Employees need to understand how their actions contribute to results—and how those results tie back to their pay.
• Review and adapt regularly: Business conditions change. So should your bonus plan. Annual reviews can help you stay aligned.

Long-Term Incentives: Creating Ownership in Private Companies

Here is a detailed, plain-text explanation of how long-term incentives—specifically stock options, restricted stock units (RSUs), and phantom stock—work in private companies, including clear mechanics, real-world-style examples, and deeper insight into why and when each is appropriate.

Long-Term Incentives: Creating Ownership in Private Companies

Short-term bonuses can be highly effective motivators, but they don’t always foster loyalty or long-term thinking. Long-term incentive plans (LTIPs) are designed to fill that gap. They provide employees with financial rewards tied to the long-term success of the company, helping align individual interests with those of founders, owners, and investors.

LTIPs are especially valuable for private companies that need to retain critical employees over several years or encourage key hires to help grow the business toward a sale, IPO, or long-term sustainable operation.

Private companies typically use three main types of long-term incentives:

• Stock Options
• Restricted Stock Units (RSUs)
• Phantom Stock

Each of these has unique mechanics, tax implications, pros, and tradeoffs. Here’s how they work.

Stock Options: Rewarding Future Growth

How They Work

Stock options give employees the right (but not the obligation) to purchase company stock in the future at a fixed price, known as the exercise price or strike price. This price is set at the time the option is granted and typically reflects the fair market value of the company’s stock at that time.

The options vest over time—meaning the employee earns the right to buy a percentage of their shares each year, usually over four years. Once vested, they can “exercise” the option by buying shares at the strike price. If the company increases in value, the employee can profit by selling the shares at a higher price.

Vesting Schedule Example

• Year 1: 25% of shares vest (known as a 1-year “cliff”)
• Years 2–4: Remaining 75% vest monthly or quarterly

Financial Example

Let’s say an early-stage startup grants 10,000 stock options to a new engineering lead:

• Strike price: $1 per share (fair market value at the time of grant)
• Vesting: 4 years with a 1-year cliff
• Exit price (at acquisition, 5 years later): $10 per share

After four years, the employee is fully vested. At acquisition, the value per share is now $10. They exercise all 10,000 options, paying $10,000 (10,000 × $1). They then sell the shares for $100,000 (10,000 × $10), making a $90,000 gain.

Best Practices for Private Companies

• Use time-based vesting to promote retention
• Communicate the risk-reward tradeoff: Stock options have upside, but no guaranteed value
• Help employees understand taxation: Especially around when they exercise and what’s owed
• Provide financial modeling tools: Show scenarios of what the shares could be worth at different exit values

When Stock Options Are Most Effective

• In early-stage companies with high growth potential but limited cash
• When targeting employees who value long-term upside
• For executive or technical roles where retention is critical

Restricted Stock Units (RSUs): Offering Ownership Without Buy-In

How They Work

RSUs are company shares promised to employees at a future date, usually once a vesting schedule is met. Unlike stock options, employees don’t need to pay to receive the shares. Once RSUs vest, the employee owns the shares outright.

However, RSUs typically don’t provide liquidity (i.e., they can’t be sold for cash) until a liquidity event such as an IPO or acquisition. Until then, the shares may have “paper value” but no practical financial use for the employee.

Key Differences from Stock Options

• RSUs do not require employees to buy shares
• RSUs are taxed as ordinary income when vested
• They always have some value, even if the company hasn’t grown significantly

Financial Example

A mid-stage B2B software company grants a product manager 2,000 RSUs:

• Current valuation: $8 per share
• Vesting schedule: 25% per year over 4 years

In Year 4, the company is acquired for $20 per share. The employee now owns 2,000 shares, which they sell for $40,000. Because no exercise was required, the entire amount is taxable as income (or possibly capital gains depending on the holding period and company structure).

Pros

• Simple to understand
• No cash required from employees
• Always has some value if the company is still operating

Cons

• Taxed when vested—even if there’s no liquidity
• May feel less rewarding if employees don’t understand the long-term value

Best Practices for Private Companies

• Communicate how RSUs differ from options
• Explain the timing of taxation clearly
• Consider granting RSUs to employees in later-stage roles or those less familiar with equity mechanics
• Use milestone-based vesting for strategic goals (e.g., product launch, team expansion)

When RSUs Are Most Effective

• In mid- to late-stage companies with a clearer exit horizon
• For executives, key contributors, or teams involved in near-term milestones
• In industries where employees are less familiar with startup equity

Phantom Stock: Mimicking Equity Without Giving It Away

How It Works

Phantom stock is a long-term cash incentive tied to the value of the company’s stock, but no actual shares are issued. Instead, employees are awarded “phantom” shares that act like real ones. When a triggering event occurs—such as a sale, acquisition, or annual valuation increase—the company pays employees a cash bonus equal to the value of those shares.

There’s no ownership, no voting rights, and no dilution of actual equity. It’s essentially a cash bonus plan with equity-like performance metrics.

Phantom stock is often structured with a vesting schedule and a payout formula based on either:

• The increase in company valuation over time
• A fixed share value at the time of a sale or other liquidity event

Financial Example

A marketing director at a growing private e-commerce company is granted 5,000 phantom shares:

• Grant value: $5 per share
• Exit value: $20 per share (at acquisition 3 years later)

At exit, the employee receives a $75,000 cash payout:
(5,000 × ($20 – $5) = $75,000)

This mirrors what they would have earned with actual equity but without having to exercise, hold stock, or worry about dilution.

Key Benefits

• No actual stock is issued—simplifies legal structure
• Payouts are cash-based—no equity complications
• Can be highly customizable and performance-driven

Limitations

• Requires cash on hand for payouts
• Still subject to tax as ordinary income
• No ownership or voting rights

Best Practices for Private Companies

• Link phantom stock to meaningful metrics: like valuation increases, EBITDA milestones, or cumulative revenue
• Create clear payout triggers: liquidity events, annual reviews, or predefined valuation events
• Define vesting rules: to promote long-term retention
• Align with cash forecasting: so the company can honor large payouts if needed

When Phantom Stock Is Most Effective

• In companies that don’t want to give up equity
• Where a future exit is possible but uncertain
• In countries or jurisdictions where equity grants are heavily taxed or complex to administer
• For senior employees who value upside but don’t want the complexity of ownership

Which Long-Term Incentive Fits Your Company?

Incentive Type	Best For	Value Depends On	Employee Pays to Participate	Payout Form	Common Use Cases
Stock Options	Early-stage employees, technical roles	Increase in share price	Yes (to exercise)	Shares or cash at sale	Startups, venture-backed firms
RSUs	Key contributors, senior hires	Share value at vesting	No	Shares (or cash equivalent)	Growth-stage firms, executive roles
Phantom Stock	Senior staff, companies avoiding equity dilution	Company valuation / trigger	No	Cash bonus	Family businesses, cash-rich companies

Each of these plans can be adapted to fit the size, structure, goals, and growth trajectory of your company. Many successful private companies use a mix of all three, often layered with short-term incentives like bonuses and company-wide rewards such as profit-sharing.

Profit-Sharing: Linking Compensation to Business Success

Profit-sharing plans reward employees when the company performs well financially. They’re especially useful in service businesses, family-run enterprises, and companies where equity isn’t practical.

How It Works

• A percentage of annual profits (e.g. 10%) is set aside for employee bonuses
• Payouts are distributed based on salary, tenure, or performance
• Plans may be discretionary or formula-based

Example:
A 25-person agency earns $2 million in profit. The company distributes $200,000 to employees. Staff receive payouts ranging from $2,000 to $15,000 depending on seniority and performance.

Benefits of Profit-Sharing

• Reinforces the connection between company success and employee rewards
• Encourages long-term thinking
• Helps retain talent, especially during profitable years

Tips for implementation:

• Define a clear and transparent formula
• Decide whether to use base salary or equal weighting to determine shares
• Choose payout timing that aligns with your cash flow cycle
• Consider setting thresholds (e.g. no payout unless profits exceed $500,000)

Implementing Incentive Plans: Step-by-Step

Creating an incentive plan is more than just choosing between bonuses or equity. It’s about building a program that fits your culture, strategy, and financial model.

Step 1: Identify What You Want to Drive

Before designing any incentive program, you must identify the core behaviors and business outcomes you want to influence. Incentive plans are not just about generosity—they are tools to drive specific results. Without clear objectives, even the most generous plans will fail to deliver a return.

Start by asking:

• What are our most critical business goals over the next 12–36 months?
• Where do we need stronger performance or accountability?
• What do we want our people to care about more deeply?
• What behaviors, habits, or outputs will move the company forward the fastest?

Here are some common goals and how incentive plans can support them:

Increase Sales or Revenue

If your primary growth strategy is revenue-driven—through new customer acquisition, upselling, or increasing lifetime value—then you want your team to focus on closing deals, expanding contracts, or shortening sales cycles.

Recommended incentives:

• Individual sales bonuses tied to quota attainment or revenue milestones
• Team-based revenue sharing for outbound teams or partnerships
• Commission structures with accelerators (e.g., higher rates once quota is exceeded)

Example:
A SaaS company sets a quarterly bonus of 10% for sales reps who hit $100K in new bookings and 15% for those who exceed $150K. SDRs are given incentives for booked demos and qualified pipeline.

Launch a New Product or Initiative

Launching a new product requires cross-functional coordination. You may want to incentivize a project team—including product, engineering, marketing, and customer success—to meet timeline and quality benchmarks.

Recommended incentives:

• Milestone-based team bonuses for on-time product delivery
• Equity grants for early contributors to core intellectual property
• Completion bonuses tied to product revenue within 6–12 months post-launch

Example:
A product team receives a $20,000 bonus pool for launching a beta MVP within 90 days and an additional $30,000 for reaching 1,000 active users within 6 months.

Improve Retention and Employee Engagement

If you’re struggling with employee churn, especially among mid- or senior-level talent, you may need to emphasize incentives that reward long-term commitment and loyalty.

Recommended incentives:

• Time-based equity grants (stock options, RSUs)
• Phantom stock or deferred cash payouts after 3+ years
• Retention bonuses tied to tenure milestones

Example:
An engineering lead is granted phantom shares worth $50,000, vesting over four years. The payout occurs if the company is acquired or when a defined EBITDA threshold is met.

Reward Long-Term Loyalty

Even if retention isn’t currently an issue, you may want to proactively build a “stickier” culture—especially for employees who are key to your IP, customer relationships, or core systems.

Recommended incentives:

• Annual equity refreshers
• Deferred profit-sharing programs
• Anniversary-based bonuses or stock grants

Example:
Employees who stay for 5 years receive a cash bonus equal to one month’s salary and an additional 2,000 RSUs that vest over the following 2 years.

Encourage Cross-Functional Collaboration

Silos can kill scaling companies. Incentives can promote collaboration across departments by rewarding collective outcomes rather than isolated performance.

Recommended incentives:

• Shared KPIs and bonus pools
• Project-based milestone bonuses
• Company-wide profit-sharing programs

Example:
A marketing and customer success team is awarded a shared bonus for reducing churn by 20% over a six-month period. Both departments are scored jointly on NPS and renewal rates.

Step 2: Choose the Right Structure

Once you know what you’re trying to drive, you need to choose the right tool—or mix of tools—for the job. Incentive structures can be grouped into three broad categories: bonuses, equity, and profit-sharing.

Each has strengths and tradeoffs. Let’s break them down.

Bonuses

Bonuses are cash payments tied to performance over a defined period—monthly, quarterly, or annually.

Best for:

• Driving short-term goals
• Sales, marketing, and operations
• Roles with clear and measurable outputs

Advantages:

• Simple to implement
• Easy to track and measure
• Immediate gratification = immediate behavior change

Limitations:

• Doesn’t promote long-term retention
• Risk of entitlement if not linked to performance

Example structures:

• Commission plans
• Quarterly KPI-based bonuses
• Spot bonuses for exceptional performance

Equity Incentives

Equity provides employees with partial ownership—or the promise of future ownership—in the company. It can take the form of stock options, RSUs, or phantom stock.

Best for:

• Retaining high-potential or critical employees
• Aligning employees with long-term growth
• Startups and early-stage companies

Advantages:

• Aligns employees with company valuation
• Promotes long-term thinking and loyalty
• Doesn’t require immediate cash outlay

Limitations:

• Complex to explain and administer
• May feel abstract to employees if not clearly communicated
• Vesting schedules delay gratification

Example structures:

• 4-year vesting schedules with 1-year cliffs
• Milestone-based equity grants
• Phantom stock tied to valuation or EBITDA triggers

Profit-Sharing

Profit-sharing allocates a portion of company profits to employees. It’s typically paid out annually and scaled based on salary, performance, or tenure.

Best for:

• Mature private companies with stable profitability
• Service firms and agencies
• Organizations emphasizing team culture

Advantages:

• Creates ownership mindset
• Encourages teamwork over individualism
• Tied to actual business performance

Limitations:

• Requires consistent profitability
• Can create disappointment in low-profit years

Example structures:

• 10% of profits allocated to an employee pool
• Equal distribution or weighted by salary
• Paid out quarterly or annually

Combining structures is often most effective. For example, sales reps may receive commissions and stock options. Product leaders may receive milestone bonuses and phantom equity. Company-wide bonuses can sit on top of individual or team plans.

Step 3: Define Eligibility and Metrics

Not every employee should—or needs to—participate in every incentive program. Defining eligibility ensures your incentives are targeted and sustainable.

Determine Who Is Eligible

Eligibility should be based on role, impact, and alignment with the intended outcomes. Consider factors such as:

• Job function: Does the role contribute directly to the performance metric?
• Seniority: Are they responsible for leading others toward key outcomes?
• Tenure: Has the employee been with the company long enough to warrant inclusion?
• Performance track record: Are they consistently delivering results?

Example policy:

• Sales bonuses apply to quota-carrying reps only
• Profit-sharing is available to all full-time employees after 6 months
• Equity grants are reserved for managers and above

Define Success Metrics

Incentives only work when people know what they’re working toward. Your metrics must be:

• Measurable: Quantifiable through systems or reports
• Relevant: Tied to business strategy
• Controllable: Employees must feel they can influence them
• Transparent: Everyone should understand how performance is calculated

Examples of metrics:

• Sales booked
• NPS or CSAT
• Product delivery timelines
• Revenue growth
• Churn reduction
• Internal efficiency (e.g., cost savings, error rates)

For company-wide plans, use broad metrics like profitability, net revenue, or milestone completions.

Step 4: Set the Rules and Communicate Clearly

This step is often overlooked, but it’s one of the most important. A good incentive plan is only as strong as its communication and clarity.

Outline Your Plan in Writing

Include the following in your plan documentation:

• Plan objectives: Why it exists
• Eligibility requirements
• Performance criteria: What’s being measured and how
• Vesting schedule (if applicable)
• Payout calculation method
• Timing of payouts
• Tax implications (high-level guidance)
• What happens on termination or leave
• Appeals or exceptions process

This document should be shared with employees upon enrollment and updated annually.

Host Plan Launch Sessions

Walk employees through the plan in a live session or recorded video. Cover:

• How they earn rewards
• What success looks like
• When and how payouts occur
• Where to find help or ask questions

Use visuals, examples, and real-life scenarios. Keep language clear—avoid legal jargon.

Offer Ongoing Support

Create a one-pager or internal wiki that includes:

• FAQs
• Visual examples
• Calculator or simulator (for bonus or equity values)
• Contact person for support

A well-informed employee is a more motivated one.

Step 5: Monitor, Adjust, and Evolve

Your company will change. Your teams will grow. Your incentive plans must evolve too.

Track Key Metrics

Establish a regular cadence (monthly or quarterly) to review:

• Participation rates
• Payout amounts
• Performance vs. target
• Employee satisfaction
• Attrition by compensation tier
• Cost of incentives as % of revenue or profit

Use dashboards, HR analytics, or finance tools to maintain visibility.

Gather Feedback

Check in with managers and employees. Ask:

• Do people understand the plan?
• Is it motivating the right behavior?
• Are there unintended consequences?
• Is the payout process smooth and timely?

Use surveys, 1-on-1s, and post-payout reviews to collect insights.

Make Annual Adjustments

Review and revise annually to reflect:

• New strategic goals
• Market compensation benchmarks
• Organizational changes
• Budget adjustments
• Equity pool recalibration

Clearly communicate changes well in advance. Offer context and invite questions.

Common Pitfalls to Avoid

• Overcomplicating the plan: Simple plans are more likely to be understood, adopted, and appreciated.
• Setting unrealistic targets: If employees don’t believe they can achieve incentives, they won’t try.
• Failing to communicate: Lack of clarity about how the plan works leads to frustration.
• Ignoring tax implications: Equity and cash incentives can carry tax consequences for employees. Always provide guidance.
• Neglecting refreshers: Incentives lose power over time. Ongoing grants or reviews keep them effective.

FAQs About Incentive Plans for Private Companies