Startup Equity FAQ

Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs) differ primarily in their tax treatment. ISOs receive favorable tax treatment under IRC Section 422, where no ordinary income tax is due at exercise if you meet holding requirements (hold shares for at least 2 years from grant and 1 year from exercise). Gains are taxed as long-term capital gains. However, the spread at exercise may trigger Alternative Minimum Tax (AMT).

NSOs are taxed at exercise as ordinary income on the spread between exercise price and fair market value, with that amount subject to income and payroll taxes. ISOs can only be granted to employees, while NSOs can be granted to employees, contractors, advisors, and board members. ISOs have a $100,000 annual vesting limit, and must be exercised within 90 days of termination to maintain ISO status.

Standard startup equity vesting typically follows a 4-year schedule with a 1-year cliff. Under this structure, no shares vest during the first year (the cliff period). After completing one year of service, 25% of your total grant vests immediately. The remaining 75% then vests monthly or quarterly over the next 3 years, meaning approximately 2.08% vests each month or 6.25% each quarter.

For example, with a 10,000 share grant, you would receive 2,500 shares after year one, then approximately 208 shares per month thereafter. Vesting typically stops upon termination of employment. Some companies offer accelerated vesting upon acquisition (single trigger) or upon acquisition followed by termination (double trigger). Founder vesting schedules may differ, sometimes with shorter cliffs or different total periods.

The optimal exercise timing depends on several factors including option type, current company valuation, your financial situation, and tax implications. Early exercise (exercising unvested options if permitted) can minimize taxes by starting the holding period clock and capturing a low spread, but risks forfeiting unvested shares if you leave.

Exercising ISOs early can help avoid AMT by exercising when the spread is minimal. For NSOs, exercising creates an immediate tax liability, so waiting until a liquidity event may be preferable unless you want to start the capital gains holding period. Consider exercising before a 409A valuation increase if you anticipate the company's fair market value will rise significantly.

The 90-day post-termination exercise window for ISOs creates urgency when leaving a company. Always model out the tax consequences and consider your ability to pay exercise costs and potential taxes before making a decision.

Tax implications vary significantly between ISOs and NSOs. For ISOs, there is no regular income tax at exercise, but the spread (fair market value minus exercise price) is an AMT preference item that may trigger Alternative Minimum Tax. If you hold shares for 2 years from grant and 1 year from exercise, gains are taxed as long-term capital gains (0-20%). A disqualifying disposition (selling before meeting holding periods) converts gains to ordinary income.

For NSOs, the spread at exercise is taxed as ordinary income (up to 37% federal) and is subject to payroll taxes. Your employer withholds taxes at exercise. Any subsequent gain from the exercise price is taxed as capital gains (short-term if held less than 1 year, long-term if held longer).

California and other states may have additional tax implications. Consider consulting a tax professional to model scenarios before exercising.

Early exercise allows you to purchase unvested shares before they vest, subject to the company's repurchase right if you leave before vesting. An 83(b) election, filed with the IRS within 30 days of early exercise, lets you pay taxes on the shares at their current value rather than when they vest.

This is advantageous when shares have low or zero spread (exercise price equals fair market value) because you pay minimal or no tax at exercise, and all future appreciation is taxed as capital gains rather than ordinary income. Without an 83(b) election, you would owe ordinary income tax on the spread at each vesting date, which could be substantial if the company's value increases.

The risks include: if you leave before vesting, you forfeit unvested shares but cannot recover taxes paid; if the company fails, you lose your exercise cost. The 30-day deadline is strict and cannot be extended.

Equity grants vary significantly based on stage, role, and company. General ranges for employees (not founders) at various stages: First employees (#1-5) might receive 1-2% ownership; early employees (#6-20) typically receive 0.25-1%; employees #21-50 might receive 0.1-0.5%; later employees typically receive 0.01-0.1%.

Senior executives may receive higher amounts: VP-level hires might receive 0.5-2% at Series A, decreasing at later stages. These percentages are fully diluted ownership, meaning they account for all outstanding shares, options, and reserved option pool.

As companies raise more funding, percentage ownership decreases due to dilution. Evaluate equity offers by modeling potential outcomes at various exit valuations. Consider the strike price, current 409A valuation, and how much the company might realistically be worth.

When you leave a company, several things happen to your stock options. Unvested options are typically forfeited immediately upon termination. Vested options usually have a post-termination exercise period, commonly 90 days for ISOs (to maintain ISO tax treatment) and up to 10 years for NSOs, though many companies set shorter periods.

If you don't exercise within the post-termination window, vested options are forfeited. Some companies offer extended exercise windows (1-10 years) as an employee benefit. ISOs exercised more than 90 days after termination (3 months for most departures, 1 year for disability) convert to NSOs, losing favorable tax treatment.

If you were terminated for cause, the company may have the right to cancel all options immediately. Early exercised unvested shares are typically subject to company repurchase at the lower of fair market value or your original exercise price. Review your stock option agreement and company equity plan documents for specific terms.

Stock options give you the right to purchase shares at a fixed price (strike price), while Restricted Stock Units (RSUs) are promises to deliver shares (or cash equivalent) upon vesting with no purchase required. Key differences include:

• Options require you to pay the exercise price to obtain shares; RSUs are granted at no cost
• Options only have value if the stock price exceeds the strike price (they can become "underwater"); RSUs always have value as long as the stock has value
• Options typically have a 10-year expiration; RSUs have no expiration and convert to shares upon vesting

For taxes, NSO exercise and RSU vesting are both taxed as ordinary income on the fair market value (minus exercise price for options). RSUs are common at public companies where stock price is established; options are more common at startups where the potential for appreciation is the primary value proposition. RSUs provide more certainty of value but less upside potential compared to options in high-growth scenarios.