What Type of Equity Will You Give Startup Employees

Founders: what type of equity will you give your startup employees?

I've gotten this question a lot over the past few weeks while working with accelerator cohorts and other early-stage founders.

It can seem like a simple choice, but want to lay out some differences between kinds of startup equity that can have major implications for your employees (and their tax bills) down the road.

So - in the vast majority of cases, you'll give your employees Incentive Stock Options (ISOs).

A few useful points about each type:

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• They represent the right to buy a set number of shares at a fixed price, usually called a strike price, or exercise price

• These will have a vesting schedule. Usually that is a 4-year vest with a 1-year cliff

• Typically only taxed when you eventually sell the shares, not at exercise (some exceptions here)

• Typically come with a 10-year timeframe before expiration (unless you leave the company then it shortens to a 90-day window to make an exercise choice - yikes)

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• Very similar to the ISO, except it doesn't qualify for the special tax treatment and is usually taxed both at exercise and at final sale (which is why ISO is preferred)

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• Not actually a stock "option", this form of equity is simply a promise from your employer to give you shares of the company’s stock (or the cash equivalent) on a future date—as soon as you meet certain conditions

• Because you don't have to pay to exercise, you also don't get to choose when the equity arrives - meaning you pay ordinary income tax on the shares whenever they vest

• This automatic tax moment is why most companies only issue RSUs at very late stage

Now - what do founders get? They often issue themselves RSAs, or Restricted Stock Awards, aka Founder Shares.

With RSAs, founders own the shares on the date they accept the grant and satisfy any purchase price requirements, but the shares will still be subject to vesting conditions.

I think the past year or so is a good illustration of why waiting to switch to RSUs matters. Many companies are now valued at less than they were in 2021 - meaning if the employees had been issued RSUs, they may have paid income tax on an asset that is currently worth a lot less.

Most advisors / consultants / other company builders that are not founders or employees receive NSOs.

Happy hiring!

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