The first time I ever received an equity grant, I remember when I got the equity grant agreement, I was so excited. Like, “Whoa, I actually have ownership in this company.” But then, I looked at all of the paperwork in front of me and I was like, “What does any of this mean?” And I literally called my dad and I was like, “I don’t know what any of this means.”
I’m Nathania, and in this lesson, we’re going to follow Iris as she gets hired at her first company and receives equity for the very first time. At the end of the lesson, you’re going to understand how an equity grant works, and you’re going to wrap your head around the different types of equity that you might receive. And this is going to build a foundation for later when we start talking about buying and selling your shares, how your taxes are going to work, and all that stuff. So let’s dive in.
So, we’ve just met Iris and she just accepted a job offer. As part of that offer, she receives an equity grant. So, what is an equity grant? Well, an equity grant is part of Iris’ compensation at the company. And it’s pretty much exactly what it sounds like. In addition to her salary, the company is also granting her some equity, also known as shares, or options, or a percentage of ownership in the business.
When Iris gets started, one of the first documents that she’s going to receive is an equity grant agreement. The equity grant agreement is a piece of paper that contains a bunch of legalese around the specifics of equity that Iris is receiving. It has a lot of important details in it, such as how many shares she’ll get, the amount of money each share is worth, the timeline by which the shares will be made available to her (also known as a vesting schedule), and a whole bunch of other key information.
As we go a little deeper into the lesson, we’ll learn about each one of these things and what they mean for Iris moving forward. First, though, when Iris receives her agreement, she’s going to have to sign it. It’s free. It won’t cost her anything at the moment. But if Iris wants to receive her equity in the future, she will have to accept the agreement.
Of course, it’s important that she actually understands what she’s signing, right? So, let’s now take a look at the details of Iris’ equity grant.
You’ll notice here that Iris is receiving her equity in the form of stock options. Now, this is important. In a startup or a private company, there are two main types of equity that Iris might encounter. The first is called stock options and the second is restricted stock units, also known as RSUs. Early-stage companies tend to give stock options while more mature companies or later-stage companies tend to issue RSUs.
There are a few key differences between the two. The biggest one is that with stock options, Iris will have to actually purchase her shares or exercise her options. If she does want to receive her shares, she will have to spend some money and buy them. With RSUs, on the other hand, Iris will just own the shares outright once she meets certain conditions, like being at the company for a set amount of time, et cetera. Once she’s met those conditions, she doesn’t have to do anything else. The shares are all hers.
The second difference is how options in RSUs vest. Now, if you’ve never heard the term “vesting” before, that’s okay, we’re going to talk about vesting in just a bit. But for now, the big thing to know is that Iris won’t just sign her agreement and magically receive all her shares at once. Instead, she’ll have to earn them piece by piece over a period of time. This is what vesting is.
Typically, options vest on what’s called a single trigger, meaning there’s one single thing that has to happen in order for them to vest. Usually, this trigger is being at the company for a certain period of time. RSUs, on the other hand, often vest on a double trigger, meaning there’s another restriction that needs to happen beyond just time-based vesting. This second trigger could be a variety of things, like a sales target she needs to hit, a project she needs to complete, or even a company-level event like an acquisition or the company going public.
The third difference between options and RSUs is how they’re taxed. With options, you’ll typically be taxed when you buy and sell your shares, similar to buying and selling stock on the public market. With RSUs though, you’ll typically pay taxes when they vest.
OK, so in Iris’ case, she’s only the 37th employee at this company, which means she’s working for a pretty early-stage startup. And remember, early-stage companies tend to give options while RSUs are more likely to be issued by more mature companies. Since options are more common at the early stage and that’s what Iris is receiving, let’s go a little deeper into how stock options work.
So, if you look at Iris’ equity grant, the first thing you’ll probably notice is the type of stock option that she’s receiving. And I know what you’re probably thinking, “There are different types of stock options, too?” The answer is yes. There are multiple different types of equity in general. But then when you zoom in on those options, there are also multiple types of those.
There are two main types of stock options. There’s incentive stock options or ISOs, and then there’s non-qualified stock options or NSOs. The main difference between the two is the way that they’re taxed. With ISOs, you typically only pay taxes once you sell the shares, versus NSOs, where you’ll typically pay taxes both when you buy them and when you sell them.
There are also other tax implications, like a thing called alternative minimum tax, or AMT. But we don’t even really know what AMT is yet, right? Well, that’s OK. Just keep it in the back of your mind, and we’ll make sure to touch on tax stuff later.
All right. So, that’s all the basics around your equity grant and the different types of equity.