[Log in](https://www.holloway.com/login) 🌞🌛 [Search](https://www.holloway.com/search-preview/equity-compensation) Equity Compensation editione2.1.1 - [Glossary](https://www.holloway.com/g/equity-compensation/glossary-preview) - [Team Access and Referrals](https://www.holloway.com/s/gift-or-refer) - Share on Twitter - [hello@holloway.com](mailto:hello@holloway.com) This is a preview. [Get full access.](https://www.holloway.com/b/equity-compensation) # The Holloway Guide to _Equity Compensation_ Stock options, RSUs, job offers, and taxes—a detailed reference, including hundreds of resources, explained from the ground up, for both employees and managers. [About this Book ►](https://www.holloway.com/b/equity-compensation) editione2.1.1 Updated September 12, 2022 Credits Original Authors Joshua Levy (Holloway) Joe Wallin (Carney Bradley Spellman) Contributions and Review José Ancer (Egan Nelson LLP) Michael Brown (Fenwick & West) George Grellas (Grellas Shah LLP) Zach Holman Chris McCann (Greylock Partners) Leo Polovets (Susa Ventures) Eric Tyson Production Rachel Jepsen — Editor Andy Sparks — Editor Hope Hackett — Research Dmitriy Kharchenko & Leigh Taylor — Graphics ## [Introduction](https://www.holloway.com/g/equity-compensation/sections/introduction)9 minutes, 5 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000203%22%7D) **Equity compensation** is the practice of granting partial ownership in a company in exchange for work. In its ideal form, equity compensation aligns the interests of individual employees with the goals of the company they work for, which can yield dramatic results in team building, innovation, and longevity of employment. Each of these [contributes](https://www.holloway.com/g/equity-compensation/sections/history-and-significance) to the creation of value—for a company, for its users and customers, and for the individuals who work to make it a success. The [ways equity can be granted](https://www.holloway.com/g/equity-compensation/sections/how-equity-is-granted) as compensation—including [restricted stock](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants), [stock options](https://www.holloway.com/definitions/stock-options), and restricted stock units—are **notoriously complex**. Equity compensation involves confounding terminology, legal obscurities, and many high-stakes decisions for those who give and receive it. If you talk to enough employees and hiring managers, you’ll hear stories of how they or their colleagues met with the painful consequences of not learning enough up front. Though many people learn the basic ideas from personal experience or from colleagues or helpful friends who have been through it before, the intricacies of equity compensation are best understood by tax attorneys, corporate lawyers, and other professionals. Decisions related to [negotiating an offer](https://www.holloway.com/g/equity-compensation/sections/offers-and-negotiations) and [exercising stock options](https://www.holloway.com/g/equity-compensation/sections/stock-option-scenarios), in particular, can have **major financial consequences**. Because the value of employee equity is determined by the fate of the company, an employee’s equity may be [illiquid](https://www.holloway.com/g/equity-compensation/sections/what-is-private-stock-worth) for a long time or ultimately [worth nothing](https://www.holloway.com/g/equity-compensation/sections/growth-and-risk), while taxes and the costs of [exercise](https://www.holloway.com/definitions/exercise), if they apply, may not be recouped. Even when a company is doing well, an employee may suffer [catastrophic tax pitfalls](https://www.holloway.com/g/equity-compensation/sections/tax-dangers) because they didn’t anticipate the tax consequences of their decisions. Understanding the technicalities of equity compensation does not guarantee that fortune will smile upon you as warmly as it did [the early hires](https://www.holloway.com/g/equity-compensation/sections/history-and-significance) of Facebook. But a thorough overview can help you be informed when [discussing with professionals](https://www.holloway.com/g/equity-compensation/sections/seeking-professional-advice) for further assistance, make better decisions for your personal situation, and avoid some [common](https://www.holloway.com/g/equity-compensation/sections/tax-dangers) and [costly](https://www.holloway.com/g/equity-compensation/sections/the-amt-trap) mistakes. ### Why This Guide? The first edition of this work, written by the same lead authors as the one you’re reading now, received significant feedback and discussion [on Hacker News](https://news.ycombinator.com/item?id=10880726), [on GitHub](https://github.com/jlevy/og-equity-compensation), and from individual experts. Now, Holloway is pleased to publish this new edition of the Guide. We’ve expanded sections, added resources and visuals, and filled in gaps. There is [a lot of information](https://www.holloway.com/g/equity-compensation/sections/further-reading) about equity compensation [spread](https://www.holloway.com/definitions/spread-and-bargain-element) across blogs and articles that focus on specific components of the topic, such as [vesting](https://www.holloway.com/definitions/vesting), types of [stock options](https://www.holloway.com/definitions/stock-options), or equity levels. We believe there is a need for a consolidated and shared resource, written by and for people on different sides of compensation decisions, including employees, hiring managers, founders, and students. Anyone can feel overwhelmed by the complex details and high-stakes personal choices that this topic involves. This reference exists to answer the needs of beginners and the more experienced. Holloway and our contributors are motivated by a single purpose: To help readers understand important details and their contexts well enough to make better decisions themselves. The Guide aims to be **practical** (with concrete suggestions and pitfalls to avoid), **thoughtful** (with context and multiple expert perspectives, including divergent opinion on controversial topics), and **concise** (it is dense but contains only notable details—still, it’s at least a three-hour read, with links to three hundred sources!). The Guide does not purport to be either perfect or complete. A reference like this is always in process. That’s why we’re currently testing features to enable the Holloway community to suggest improvements, contribute new sections, and call out anything that needs revision. We welcome (and will gladly credit) your help. We especially wish to [recognize](https://www.holloway.com/g/equity-compensation/sections/credits) the dozens of people who have helped write, review, edit, and improve it so far—and in the future—and hope you’ll check back often as it improves. ### Scope This Guide **currently covers**: - Equity compensation in **[C corporations](https://www.holloway.com/definitions/c-corporation-or-c-corp)** in the **United States**. - Equity compensation for most employees, advisors, and independent contractors in [private companies](https://www.holloway.com/definitions/private-companies), from startups through larger private [corporations](https://www.holloway.com/definitions/corporation-and-stock-corporation-and-non-stock-corporations). - Limited coverage of equity compensation in [public companies](https://www.holloway.com/definitions/public-companies). Topics **not yet covered**: - Equity compensation programs, such as [ESPPs](https://www.investopedia.com/terms/e/espp.asp) in [public companies](https://www.holloway.com/definitions/public-companies). (We’d like to see this improve in the future.) - Full details on executive equity compensation. - Compensation outside the United States. - Compensation in companies other than [C corporations](https://www.holloway.com/definitions/c-corporation-or-c-corp), including [LLCs](https://en.wikipedia.org/wiki/Limited_liability_company) and [S corporations](https://en.wikipedia.org/wiki/S_corporation), where equity compensation is approached and practiced in very different ways. For these situations, see [other resources](https://www.holloway.com/g/equity-compensation/sections/when-to-turn-elsewhere) and get [professional advice](https://www.holloway.com/g/equity-compensation/sections/seeking-professional-advice). ### Who May Find This Useful Our aim is to be as helpful to the beginner as to those with more experience. Having talked with employees, CEOs, investors, and lawyers, we can assure you that no matter how much you know about equity compensation, you will likely run into confusion at some point. If you’re an **employee** or a **candidate for a job**, some of these may apply to you: - You’ve heard phrases like _stock_, _[stock options](https://www.holloway.com/definitions/stock-options)_, _[strike price](https://www.holloway.com/definitions/strike-price-or-exercise-price)_, _[ISOs](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options)_, _[RSUs](https://www.holloway.com/definitions/restricted-stock-units-or-rsus)_, _[83(b) election](https://www.holloway.com/definitions/83-b-election)_, _[409A valuation](https://www.holloway.com/definitions/409a-valuation)_, _[AMT](https://www.holloway.com/definitions/alternative-minimum-tax-or-amt)_, or _[early exercise](https://www.holloway.com/definitions/early-exercise-or-forward-exercise)_ and know they are probably important but are mystified by what some of them really mean or whether they apply to your situation. - You’re considering a job offer but don’t know how to [navigate or negotiate](https://www.holloway.com/g/equity-compensation/sections/offers-and-negotiations) the equity component of the offer. - You’re joining a startup for the first time and are overwhelmed by all the [paperwork](https://www.holloway.com/g/equity-compensation/sections/documents-and-agreements). - You’re quitting, taking a leave of absence, or are being laid off or fired from a company where you have stock or options and are thinking through the decisions and consequences. - A company you work for is going through an [acquisition](https://www.holloway.com/definitions/acquisition-and-sale), [IPO](https://www.holloway.com/definitions/initial-public-offering-or-ipo-and-goes-public), or shutdown. - You have stock in a [private company](https://www.holloway.com/definitions/private-companies) and [need cash](https://www.holloway.com/g/equity-compensation/sections/stock-option-scenarios). **Founders** or **hiring managers** who need to talk about equity compensation with employees or potential hires will also find this Guide useful. As many entrepreneurs and hiring managers will tell you, this topic isn’t easy on that side of the table, either! Negotiating with candidates and fielding questions from candidates and employees requires understanding the same complex technicalities of equity compensation well. That said, this topic is **not simple** and we ask that readers be willing to invest time to get through a lot of confusing detail. If you’re in a hurry, or you don’t care to learn the details, this Guide may not be for you. [Seek advice](https://www.holloway.com/g/equity-compensation/sections/seeking-professional-advice). ### A Note on Fairness Much of what you read about equity compensation was written by a single person, from a single vantage point. The authors and editors of this Guide have navigated the territory of equity compensation from the perspective of employees, hiring managers, founders, and lawyers. We do believe that the knowledge here, [combined with professional advice](https://www.holloway.com/g/equity-compensation/sections/seeking-professional-advice), can make a significant difference for **both employees and hiring managers**. One of the difficulties for candidates negotiating equity compensation is that they may have less information about what they are worth than the person hiring them. Companies talk to many candidates and often have access to or pay for expensive market-rate compensation data. While some data on [typical equity levels](https://www.holloway.com/g/equity-compensation/sections/typical-employee-equity-levels) have been published online, much of it fails to represent the value of a candidate with their own specific experience in a specific role. However, even without exact data, candidates and hiring managers can develop better mental frameworks to think about [offers and negotiations](https://www.holloway.com/g/equity-compensation/sections/offers-and-negotiations). On the other hand, challenges are not limited to those of employees. Founders and hiring managers also often struggle with talking through the web of technicalities with potential hires, and can make equally poor decisions when making offers. Either over-compensating or under-compensating employees can have unfortunate consequences. In short, both companies and employees are routinely hurt by uninformed decisions and costly mistakes when it comes to equity compensation. A shared resource is helpful for both sides. ## [Roadmap](https://www.holloway.com/g/equity-compensation/sections/roadmap)6 minutes, 2 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000783%22%7D) ### The Holloway Reader The Holloway Reader you’re using now is designed to help you find and navigate the material you need. **Use the search box.** It will reveal definitions, section-by-section results, and content contained in **the hundreds of resources we’ve linked to** throughout the Guide. Think of it as a mini library of the best content on equity compensation. We also provide mouseover (or short tap on mobile) for **definitions of terms**, related section suggestions, and external links while you read. ### How This Guide Is Organized This Guide contains a lot of material. And it’s dense. Some readers may wish to read front to back, but you can also **search or navigate directly** to parts that are of interest to you, **referring back** to foundational topics as needed. Equity compensation lies at the intersection of corporate law, taxation, and employee compensation, and so requires some basic understanding of all three. You might think compensation and taxation are separate topics, but they are so intertwined it would be misleading to explain one without the other. We cover material in logical order, so that if you do read the earlier sections first, later sections on the interactions of tax and compensation will be clearer. We start with [**Equity Compensation Basics**](https://www.holloway.com/g/equity-compensation/sections/equity-compensation-basics): What compensation and equity are, and why equity is used as compensation. But before we get much further, we need to talk about what stock is, and how companies are formed. [**Fundamentals of Stock Corporations**](https://www.holloway.com/g/equity-compensation/sections/fundamentals-of-stock-corporations) covers how companies organize their ownership, how stock is issued, [public companies](https://www.holloway.com/definitions/public-companies) and [private companies](https://www.holloway.com/definitions/private-companies), and [IPOs](https://www.holloway.com/definitions/initial-public-offering-or-ipo-and-goes-public) and [liquidity](https://www.holloway.com/definitions/liquidity-and-exits-and-liquidity-events-and-liquidations) (which determine when equity is worth cash). This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### When to Turn Elsewhere **CEOs**, **CFOs**, **COOs**, or anyone who runs a company or team of significant size should be sure to talk to an equity compensation consultant or a specialist at a law firm to learn about equity compensation plans. **Founders** looking for an introduction to the legalities of running a company may wish to check out [_Legal Concepts for Founders_](https://handbook.clerky.com/), from Clerky, in addition to talking to a lawyer. Founders should also lean on their investors for advice, as they may have additional experience. **Executive compensation** at large or [public companies](https://www.holloway.com/definitions/public-companies) is an even more nuanced topic, on both sides of the table. Hire an experienced lawyer or compensation consultant. There are extensive legal [resources](https://www.compensationstandards.com/home/) available on executive compensation. ### Seeking Professional Advice This Guide does not replace professional advice. Please read the full [disclaimer](https://www.holloway.com/g/equity-compensation/sections/disclaimer) and seek professional advice from a lawyer, tax professional, or other compensation expert before making significant decisions. Does that make reading through these details a waste of time? Not at all. Important decisions rarely should or can be blindly delegated. This Guide _complements but does not replace_ the advice you get from professionals. Working with the support of a professional can help you make better decisions when you have an understanding of the topic yourself and know what questions to ask. ## [Equity Compensation Basics](https://www.holloway.com/g/equity-compensation/sections/equity-compensation-basics)7 minutes, 25 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000823%22%7D) ### History and Significance Companies ranging from two-person startups to the [Fortune 500](https://fortune.com/fortune500/) have found that granting partial ownership in a company is among the best methods to attract and retain exceptional talent. In the United States, partial ownership through [stock options](https://www.holloway.com/g/equity-compensation/sections/stock-options) has been a key part of pay for executives and other employees since the 1950s.[\*](https://corpgov.law.harvard.edu/2014/10/02/what-has-happened-to-stock-options/) As recently as 2014, **7.2%** of all private sector employees ( **8.5 million** people) and **13.1%** of _all_ employees of companies with stock held [stock options](https://www.holloway.com/definitions/stock-options), according to the National Center for Employee Ownership.[\*](https://www.nceo.org/assets/pdf/articles/GSS-2014-data.pdf) Many believe employee ownership has ​paid​ [fostered innovations](https://www.wsj.com/articles/reviving-the-flagging-spirit-of-silicon-valley-1428706671) in technology, especially in Silicon Valley, from the [early days](https://www.hp.com/hpinfo/abouthp/histnfacts/publications/measure/pdf/1976_07.pdf) of Hewlett-Packard to recent examples like Facebook. Stock options helped the first 3,000 employees of Facebook enjoy roughly **$23 billion** at the time the company went public.[\*](https://www.ft.com/content/d6599ae0-5738-11e1-869b-00144feabdc0) ​controversy​ Some controversy surrounds the use of equity compensation for high-paid executives. [Public companies](https://www.holloway.com/definitions/public-companies) offer executives equity compensation in no small part because of a tax loophole. In 1993, President Bill Clinton attempted to limit executive pay with a new section[\*](https://home.treasury.gov/system/files/131/Firms-Exceeding-162m.pdf) of the Internal Revenue Code. Unfortunately, the legislation backfired; a loophole made performance-based pay—including stock options—fully tax deductible, thereby creating a dramatic incentive to pay executives through [stock options](https://www.holloway.com/definitions/stock-options).[\*](https://www.epi.org/publication/taxes-executive-compensation/) From 1970–79, the average compensation for a CEO of one of the 50 largest firms in the United States was **$1.2M**, of which **11.2%** was from stock options. By 2000–05, the same numbers had risen to **$9.2M** and **37%**, respectively.[\*](https://www.nber.org/system/files/working_papers/w16585/w16585.pdf) ### Growth and Risk Generally, equity compensation is closely linked to the **growth** of a company. Cash-poor startups persuade early employees to take pay cuts and join their team by offering meaningful [ownerships stakes](https://www.holloway.com/g/equity-compensation/sections/typical-employee-equity-levels), catering to hopes that the company will one day grow large enough to [go public](https://www.holloway.com/g/equity-compensation/sections/ipos) or [be sold](https://www.holloway.com/g/equity-compensation/sections/sales-and-liquidity) for an ample sum. More mature but still fast-growing companies find offering compensation linked to ownership is more attractive than high cash compensation to many candidates. With the hope for growth, however, also comes **risk**. Large, fast-growing companies often hit hard times. And [startups](https://www.holloway.com/g/equity-compensation/sections/startups-and-growth) routinely fail or yield no returns for investors or workers. According to [a report](https://fortune.com/2017/06/27/startup-advice-data-failure/) by Cambridge Associates and Fortune Magazine, between 1990 and 2010, **about 60%** of [venture capital](https://www.holloway.com/definitions/venture-capital-and-venture-capitalists-or-vcs)-backed companies returned less than the original investment, leaving employees with the painful realization that their startup was not, in fact, the next Google. Of the remaining **40%**, just a select few go on to make many of their employees wealthy, as has been the case with iconic high-growth companies, like Starbucks,[\*](https://www.investopedia.com/articles/markets/101415/biggest-risks-investing-starbucks-stock.asp) UPS,[\*](https://money.cnn.com/1999/11/10/companies/ups/) Amazon,[\*](https://techcrunch.com/2017/06/28/a-look-back-at-amazons-1997-ipo/) Google,[\*](https://archive.nytimes.com/dealbook.nytimes.com/2009/08/19/googles-ipo-5-years-later/) or Facebook.[\*](https://en.wikipedia.org/wiki/Initial_public_offering_of_Facebook) ### Compensation and Equity ​Definition​**Compensation** is any remuneration to a person (including employees, contractors, advisors, founders, and board members) for services performed or rendered to a company. Compensation comes in the forms of cash pay (salary and any bonuses) and any non-cash pay, including [benefits](https://en.wikipedia.org/wiki/Employee_benefits#United_States) like health insurance, family-related protections, perks, and retirement plans. Company strategies for compensation are [far from simple](https://review.firstround.com/counterintuitive-comp-tips-for-the-unwary-and-uninitiated). Beth Scheer, head of talent at the venture fund Homebrew, offers a [thoughtful overview](https://quip.com/HEB3Ah9dYD6o) of compensation in startups. Another term you may encounter is [_total rewards_](https://worldatwork.org/media/pdf/2020_BRO_TRModel_J16197_FNL.pdf), which refers to a model of attracting and retaining employees using a combination of salary and incentive compensation (like equity), benefits, recognition for contribution or commitment (like awards and bonuses), training programs, and initiatives to improve the work environment. ​Definition​ In the context of compensation and investment, **equity** broadly refers to any kind of ownership in a company that can be held by individuals (like employees or board members) and by other businesses (like [venture capital](https://www.holloway.com/definitions/venture-capital-and-venture-capitalists-or-vcs) firms). One common kind of equity is stock, but equity can take other forms, such as [stock options](https://www.holloway.com/definitions/stock-options) or [warrants](https://www.holloway.com/definitions/warrants), that give ownership rights. Commonly, equity also comes with certain conditions, such as [vesting](https://www.holloway.com/definitions/vesting) or repurchase rights. Note the term _equity_ also has [several other](https://www.investopedia.com/terms/e/equity.asp) technical meanings in accounting and real estate. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### The Goals of Equity Compensation The purpose of equity compensation is threefold: - **Attract and retain talent.** When a company already has or can be predicted to have significant financial success, talented people are [incentivized](https://avc.com/2010/10/employee-equity-options/) to work for the company by the prospect of their equity being [worth a lot](https://www.entrepreneur.com/money-finance/how-stock-options-can-help-your-startup-attract-and-retain/253438) of money in the future. The actual probability of life-changing lucre may be low (or at least, lower than you may think if your entire knowledge of startups is watching “ [_The Social Network_](https://en.wikipedia.org/wiki/The_Social_Network)”). But even a small chance at winning big can be worth the risk to many people, and to some the risk itself can be exciting. - **Align incentives.** Even companies that can afford to pay lots of cash may prefer to give employees equity, so that employees work to increase the _future_ value of the company. In this way, equity aligns individuals’ incentives with the interests of the company. At its best, this philosophy fosters an environment of teamwork and a “rising tides lift all boats” mentality. It also encourages everyone involved to think [long-term](https://www.cebglobal.com/blogs/equity-compensation-will-stop-short-termism-and-boost-growth/), which is key for company success. As we’ll [discuss later](https://www.holloway.com/g/equity-compensation/sections/offers-and-negotiations), the amount of equity you’re offered usually reflects both your contribution to the company and your commitment to the company in the future. - **Reduce cash spending.** By giving equity, a company can often pay less in cash compensation to employees now, with the hope of rewarding them later, and put that money toward other investments or operating expenses. This can be essential in the early stages of a company or at other times where there may not be enough revenue to pay large salaries. Equity compensation can also help recruit senior employees or executives who would otherwise command especially high salaries. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ## [Fundamentals of Stock Corporations](https://www.holloway.com/g/equity-compensation/sections/fundamentals-of-stock-corporations)13 minutes, 35 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000785%22%7D) In this section, we describe the basics of how stock and shares are used. Those familiar with stock, [stock corporations](https://www.holloway.com/definitions/corporation-and-stock-corporation-and-non-stock-corporations), [public companies](https://www.holloway.com/definitions/public-companies), and [private companies](https://www.holloway.com/definitions/private-companies) can [jump ahead](https://www.holloway.com/g/equity-compensation/sections/how-equity-is-granted) to how those companies grant equity. ### Kinds of Companies ​Definition​ A **company** is a legal entity formed under corporate law for the purpose of conducting trade. In the United States, specific rules and regulations govern several kinds of [business entities](https://en.wikipedia.org/wiki/Types_of_business_entity#United_States). Federal and state law have significant implications on liability and taxation for each kind of company. Notable types of companies include sole proprietorships, partnerships, limited liability companies (LLCs), S corporations, and [C corporations](https://www.holloway.com/definitions/c-corporation-or-c-corp). ​Definition​ A **corporation** is a company that is legally recognized as an entity separate from its owners. The corporation itself, and not its owners, is obligated to repay debts and accountable under contracts and legal actions (that is, is a “ [legal person](https://en.wikipedia.org/wiki/Legal_person)”). Most commonly, the term _corporation_ is used to refer to a [**stock corporation (or joint-stock company)**](https://en.wikipedia.org/wiki/Joint-stock_company), which is a corporation where ownership is managed using stock. **Non-stock corporations** that do not issue stock exist as well, the most common being [nonprofit organizations](https://en.wikipedia.org/wiki/Nonprofit_organization). (A few [less common](https://en.wikipedia.org/wiki/Non-stock_corporation) for-profit non-stock corporations also exist.) In practice, people often use the word _company_ to mean _corporation_. ​Definition​**Incorporation** is the [legal process](https://en.wikipedia.org/wiki/Incorporation_(business)) of forming (or **incorporating**) a new corporation, such as a business or nonprofit. Corporations can be created in any country. In the United States, incorporation is handled by state law, and involves filing [articles of incorporation](https://en.wikipedia.org/wiki/Articles_of_incorporation) and a variety of other [required information](https://handbook.clerky.com/formation/process) with the Secretary of State. (Note that the formation of companies that are not corporations, such as partnerships or LLCs, is not the same as incorporation.) This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Stock and Shares ​Definition​[**Stock**](https://en.wikipedia.org/wiki/Stock) is a legal invention that represents ownership in a company. [**Shares**](https://en.wikipedia.org/wiki/Share_(finance)) are portions of stock that allow a company to grant ownership to a variety of people or other companies in flexible ways. Each **shareholder (or stockholder)**, as these owners are called, holds a specific number of shares. Founders, investors, employees, [board members](https://www.holloway.com/definitions/board-of-directors-and-inside-directors-and-outside-directors-and-board-members-and-board-seat), contractors, advisors, and other companies, like law firms, can all be shareholders. ​Definition​ Stock ownership is often formalized on **stock certificates**, which are fancy pieces of paper that prove who owns the stock. Sometimes you have stock but don’t have the physical certificate, as it may be held for you at a law office. Some companies now manage their ownership through online services called _ownership management platforms_, such as [Carta](https://carta.com/). If the company you work for uses an ownership management platform, you will be able to view your stock certificates and stock values online. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Public and Private Companies ​Definition​[**Public companies**](https://en.wikipedia.org/wiki/Public_company) are [corporations](https://www.holloway.com/definitions/corporation-and-stock-corporation-and-non-stock-corporations) in which any member of the public can own stock. People can buy and sell the stock for cash on public [stock exchanges](https://www.investopedia.com/terms/e/exchange.asp). The value of a company’s shares is the value displayed in the stock market reports, so [shareholders](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder) know how much their stock is worth. ​Definition​ Most smaller companies, including all startups, are [**private companies**](https://en.wikipedia.org/wiki/Privately_held_company) with owners who control how those companies operate. Unlike a public company, where anyone is able to buy and sell stock, owners of a private company control who is able to buy and sell stock. There may be few or no transactions, or they may not be publicly known. ​···​ ### Governance ​Definition​ A [corporation](https://www.holloway.com/definitions/corporation-and-stock-corporation-and-non-stock-corporations) has a **board of directors**, a [group of people](https://en.wikipedia.org/wiki/Board_of_directors) whose legal obligation is to oversee the company and ensure it serves the best interests of the [shareholders](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder). [Public companies](https://www.holloway.com/definitions/public-companies) are legally obligated to have a board of directors, while private companies often elect to have one. The board typically consists of **inside directors**, such as the CEO, one or two founders, or executives employed by the company, and **outside directors**, who are not involved in the day-to-day workings of the company. These **board members** are elected individuals who have legal, corporate governance rights and duties when it comes to voting on key company decisions. A board member is said to have a **board seat** at the company. Boards of directors range from 3 to 31 members, with an average size of 9; for [private companies](https://www.holloway.com/definitions/private-companies) the typical board size is typically between 3 and 7 directors.[\*](https://www.investopedia.com/articles/analyst/03/111903.asp) Boards are almost always an odd number in order to avoid tie votes. It’s worth noting that the state of California requires [public companies](https://www.holloway.com/definitions/public-companies) to have at least one woman on their boards.[\*](https://www.nytimes.com/2018/09/30/business/women-corporate-boards-california.html) Key decisions of the board are made formally in _board meetings_ or in writing (called _written consent_).[\*](https://www.dlapiperaccelerate.com/knowledge/2017/board-action-meetings-vs-written-consents.html) Equity grants have to be by the board of directors.\* ​···​ ### IPOs ​Definition​ A [private company](https://www.holloway.com/definitions/private-companies) becomes a [public company](https://www.holloway.com/definitions/public-companies) in a process called an [**initial public offering (IPO)**](https://en.wikipedia.org/wiki/Initial_public_offering). Historically, only private companies with a strong track record of years of growth have considered themselves ready to take this significant step. The IPO has [pros and cons](https://www.investopedia.com/terms/i/ipo.asp) that include exchanging a host of high regulatory costs for the benefits of significant capital. After a company “IPOs” or “ **goes public**,” investors and the general public can buy stock, and existing [shareholders](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder) can sell their stock far more easily than when the company was private. Companies take years to IPO after being formed. The median time between a company’s founding and its IPO has been increasing. According to a Harvard report, companies that went public in **2016** took **7.7 years** to do so, compared to **3.1 years** for companies that went public in **1996**.[\*](https://corpgov.law.harvard.edu/2017/05/25/2017-ipo-report/) ​···​ ### Sales and Liquidity ​danger​ With [private companies](https://www.holloway.com/definitions/private-companies), it can be very [hard to know](https://www.holloway.com/g/equity-compensation/sections/what-is-private-stock-worth) the value of equity. Because the value of private company stock is not determined by regular trades on public markets, [shareholders](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder) can only make educated guesses about the likely future value, at a time when they will be able to sell stock. After all, [private company](https://www.holloway.com/definitions/private-companies) stock is simply a legal agreement that entitles you to something of highly uncertain value, and could well be worthless in the future, or highly valuable, depending on the fate of the company. ​confusion​ We’ll discuss the notion of a company officially assigning a [fair market value](https://www.holloway.com/g/equity-compensation/sections/409a-valuations) later, but even if a company gives you a value for your stock for tax and accounting purposes, it doesn’t mean you can expect to sell it for that value! ​Definition​ An [**acquisition**](https://www.investopedia.com/terms/a/acquisition.asp) is the purchase of more than 50% of the shares of one company (the acquired company) by another company (the purchaser). This is also called a **sale** of the acquired company. In an acquisition, the acquired company cedes control to the purchaser. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ## [Startups and Growth](https://www.holloway.com/g/equity-compensation/sections/startups-and-growth)16 minutes, 43 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000001472%22%7D) If you’re considering working for a startup, what we cover next on how these early-stage companies raise money and grow is helpful in understanding what your equity may be worth. If you’re only concerned with large and established companies, you can skip ahead to [how equity is granted](https://www.holloway.com/g/equity-compensation/sections/how-equity-is-granted). ### Startups ​Definition​ A [**startup**](https://en.wikipedia.org/wiki/Startup_company) is an emerging company, typically a [private company](https://www.holloway.com/definitions/private-companies), that aspires to grow quickly in size, revenue, and influence. Once a company is established in the market and successful for a while, it usually stops being called a startup. ​confusion​ Unlike the terminology around [corporations](https://www.holloway.com/definitions/corporation-and-stock-corporation-and-non-stock-corporations), which has legal significance, the term _startup_ is informal, and not everyone uses it consistently. Startups are not the same as small businesses. Small businesses, like a coffee shop or plumbing business, typically intend to grow slowly and organically, while relying much less on investment capital and equity compensation. Distinguished startup investor [Paul Graham](https://en.wikipedia.org/wiki/Paul_Graham_(programmer)) has [emphasized](http://www.paulgraham.com/growth.html) that it’s best to think of a startup as any [early stage](https://www.holloway.com/g/equity-compensation/sections/stages-of-a-startup) company intending to grow quickly. ​technical​ [C corporations](https://www.holloway.com/definitions/c-corporation-or-c-corp) dominate the startup ecosystem. LLCs tend to be better suited for slower-growth companies that intend to distribute profits instead of re-investing them for growth. Because of this, and for complex reasons related to how their capital is raised, [venture capitalists](https://www.holloway.com/definitions/venture-capital-and-venture-capitalists-or-vcs) significantly prefer to invest in C corporations. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Fundraising, Growth, and Dilution Many large and successful companies began as startups. In general, startups rely on investors to help fund rapid growth. ​Definition​**Fundraising** is the process of seeking capital to build or scale a business. Selling shares in a business to investors is one form of fundraising, as are loans and [initial coin offerings](https://en.wikipedia.org/wiki/Initial_coin_offering). **Financing** refers both to fundraising from outside sources and to bringing in revenue from selling a product or service. ​Definition​**Venture capital** is a form of financing for early-stage companies that individual investors or investment firms provide in exchange for partial ownership, or equity, in a company. These investors are called **venture capitalists (or VCs)**. Venture capitalists invest in companies they perceive to be capable of growing quickly and commanding significant market share. “Venture” refers to the risky nature of investing in early-stage businesses—typically startups—with unproven business models. A startup goes through several [stages of growth](https://www.holloway.com/g/equity-compensation/sections/stages-of-a-startup) as it raises capital based on the hope and expectation that the company will grow and make more money in the future. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Dilution Illustrations These visualizations illustrate how ownership of a venture-backed company evolves as funding is raised. One scenario imagines changes to ownership in a well-performing startup, and the other is loosely based on a careful analysis of Zipcar,[\*](https://reactionwheel.net/2018/05/zipcar-fundraising-breakdown.html) a ride-sharing company that experienced substantial [dilution](https://www.holloway.com/definitions/dilution) before eventually going public and being [acquired](https://www.holloway.com/g/equity-compensation/sections/sales-and-liquidity). These diagrams simplify complexities such as the ones discussed in that analysis, but they give a sense of how ownership can be diluted. ​ Scenario:HypotheticalApprox. Zipcar Founding Founder #14Mshares$400value40%equityFounder #23Mshares$300value30%equityFounder #33Mshares$300value30%equity Series A Founder #14Mshares$3.22Mvalue24.73%equityFounder#23Mshares$2.41Mvalue18.55%equityFounder#33Mshares$2.41Mvalue18.55%equityOptionsPool1.5MSh.$1.21MVal.9.28%Eq.17.78% Seed — $2.31M11.11% Series A — $1.44MInvestment4.67Mshares$3.76Mvalue28.89%equity Series C Founder#14Mshares$10.9Mvalue18.17%equityFounder#23Mshares$8.18Mvalue13.63%equityFounder#33Mshares$8.18Mvalue13.63%equityOptionsPool1.5MSh.$4.09MVal.6.81%Eq.13.06% Seed — $7.84M8.16% Series A — $4.9M10.61% Series B — $6.37M15.92% Series C — $9.55MInvestment10.51Mshares$28.65Mvalue47.76%equity ​ ### Stages of a Startup Understanding the value of stock and equity in a startup requires a grasp of the stages of growth a startup goes through. These stages are largely reflected in how much funding has been raised—how much ownership, in the form of shares, has been sold for capital. Very roughly, [typical stages](http://blog.eladgil.com/2011/03/how-funding-rounds-differ-seed-series.html) are: - [**Bootstrapped**](https://www.investopedia.com/terms/b/bootstrapping.asp) (little funding or self-funded): Founders are figuring out what to build, or they’re starting to build with their own time and resources. - [**Series Seed**](https://www.investopedia.com/terms/s/seedcapital.asp) (roughly $250K to $2 million in funding): Figuring out the product and market. The low end of this spectrum is now often called **pre-seed**. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### The Option Pool ​Definition​ At some point early on, generally before the first employees are hired, a number of shares will be reserved for an employee **[option pool](https://www.investopedia.com/terms/o/option-pool.asp) (or employee pool)**. The option pool is part of a legal structure called an equity incentive plan. A typical size for the option pool is 20% of the stock of the company, but, especially for earlier stage companies, the option pool can be 10%, 15%, or other sizes. Once the pool is established, the company’s [board of directors](https://www.holloway.com/definitions/board-of-directors-and-inside-directors-and-outside-directors-and-board-members-and-board-seat) grants stock from the pool to employees as they join the company. ​technical​ Well-advised companies will reserve in the option pool only what they [expect to use](https://siliconhillslawyer.com/2014/05/01/option-pool-not-ocean-startups/) over the next 12 months or so; otherwise, given how equity grants are usually promised, they may be over-granting equity. The whole pool may never be fully used, but companies should still try not to reserve more than they plan to use. The size of the pool is determined by [complex factors](https://venturehacks.com/option-pool-shuffle) between founders and investors. It’s worth employees (and [founders](https://www.cooleygo.com/negotiating-option-pool/)) understanding that a small pool can be a good thing in that it reflects the company preserving ownership in negotiations with investors. The size of the pool may be increased later. ### Counting Shares There are some key subtleties you’re likely to come across in the way [outstanding shares](https://www.holloway.com/g/equity-compensation/sections/stock-and-shares) are counted: ​Definition​[Private companies](https://www.holloway.com/definitions/private-companies) always have what are referred to as **authorized but unissued** shares, referring to shares that are authorized in legal paperwork but have not actually been issued. Until they are issued, the [unissued stock](https://www.investopedia.com/terms/u/unissuedstock.asp) these shares represent doesn’t mean anything to the company or to [shareholders](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder): no one owns it. ​confusion​ For example, a [corporation](https://www.holloway.com/definitions/corporation-and-stock-corporation-and-non-stock-corporations) might have 100 million _authorized_ shares, but will only have _issued_ 10 million shares. In this example, the corporation would have 90 million _authorized but unissued_ shares. When you are trying to determine what percentage a number of shares represents, you do _not_ make reference to the authorized but unissued shares. ​confusion​ You actually want to know the total issued shares, but even this number can be confusing, as it can be computed [more than one way](https://www.cooleygo.com/option-grants-fully-diluted-issued-outstanding/). Typically, people count shares in two ways: _issued and outstanding_ and _[fully diluted](https://www.holloway.com/definitions/fully-diluted)_. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Classes of Stock ​Definition​ Investors often ask for rights to be paid back first in exchange for their investment. The way these different rights are handled is by creating different [**classes of stock**](https://www.upcounsel.com/classes-of-stock). (These are also sometimes called [**classes of shares**](https://www.investopedia.com/terms/c/class.asp), though that term has another meaning in the context of mutual funds.) ​Definition​ Two important classes of stock are [**common stock**](https://en.wikipedia.org/wiki/Common_stock) and [**preferred stock**](https://en.wikipedia.org/wiki/Preferred_stock). In general, preferred stock has “ [rights, preferences, and privileges](https://www.americanbar.org/groups/business_law/publications/blt/2014/01/04_bigler/)” that common stock does not have. Typically, investors get preferred stock, and founders and employees get common stock (or stock options). The exact number of classes of stock and the differences between them can vary company to company, and, in a startup, these can vary at [each round](https://www.holloway.com/g/equity-compensation/sections/stages-of-a-startup) of funding. ​confusion​ Another term you’re likely to hear is [_founders’ stock_](https://www.alleywatch.com/2013/08/what-is-founders-stock-legally/), which is (usually) common stock allocated at a company’s formation, but otherwise doesn’t have any different rights from other common stock.[\*](https://lsvp.wordpress.com/2008/09/15/what-entrepreneurs-need-to-know-about-founders-stock/) This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ## [How Equity Is Granted](https://www.holloway.com/g/equity-compensation/sections/how-equity-is-granted)25 minutes, 35 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000002083%22%7D) In this section we’ll lay out how equity is granted in practice, including the differences, benefits, and drawbacks of common types of equity compensation, including [restricted stock awards](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants), [stock options](https://www.holloway.com/definitions/stock-options), and [restricted stock units](https://www.holloway.com/definitions/restricted-stock-units-or-rsus) (RSUs). We’ll go over a few less common types as well. While the [intent](https://www.holloway.com/g/equity-compensation/sections/the-goals-of-equity-compensation) of each kind of equity grant is similar, they differ in many ways, particularly around how they are [taxed](https://www.holloway.com/g/equity-compensation/sections/taxes-on-equity-compensation). Except in rare cases where it may be negotiable, the type of equity you get is up to the company you work for. In general, larger companies grant [RSUs](https://www.holloway.com/definitions/restricted-stock-units-or-rsus), and startups grant [stock options](https://www.holloway.com/definitions/stock-options), and occasionally executives and very early employees get [restricted stock awards](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants). ​···​ ### Restricted Stock Awards At face value, the most direct approach to equity compensation would be for the company to award stock to an employee in exchange for work. In practice, it turns out a company will only want to do this with restrictions on how and when the stock is fully owned. Even so, this is actually one of the least common ways to get equity. We mention it first because it is the simplest form of equity compensation, useful for comparison as things get more complex. ​Definition​ A **restricted stock award** is when a company grants someone stock as a form of compensation. The stock awarded has additional conditions on it, including a [vesting schedule](https://www.holloway.com/definitions/vesting-schedule), so is called **restricted stock**. Restricted stock awards may also be called simply **stock awards** or **stock grants**. ​technical​ What _restricted_ means here is actually [complex](https://github.com/jlevy/og-equity-compensation/issues/24). It refers to the fact that the stock (i) has certain restrictions on it (like transfer restrictions) required for [private company](https://www.holloway.com/definitions/private-companies) stock, and (ii) will be subject to repurchase at cost pursuant to a [vesting schedule](https://www.holloway.com/definitions/vesting-schedule). The repurchase right lapses over the service-based [vesting](https://www.holloway.com/definitions/vesting) period, which is what is meant in this case by the stock “vesting.” This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Stock Options ​Definition​[**Stock options**](https://en.wikipedia.org/wiki/Employee_stock_option) are contracts that allow individuals to buy a specified number of shares in the company they work for at a fixed price. Stock options are the most common way early-stage companies grant equity. ​Definition​ A person who has received a stock option grant is not a [shareholder](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder) until they **exercise** their option, which means purchasing some or all of their shares at the strike price. Prior to exercising, an option holder does not have voting rights. ​Definition​ The **strike price (or exercise price)** is the fixed price per share at which stock can be purchased, as set in a stock option agreement. The strike price is generally set lower (often much lower) than what people expect will be the _future_ value of the stock, which means selling the stock down the road could be profitable. ​confusion​ _Stock options_ is a confusing term. In investment, an _option_ is a right (but not an obligation) to buy something at a certain price within a certain time frame. You’ll often see stock options discussed in the context of [investment](https://www.investopedia.com/terms/s/stockoption.asp). What investors in financial markets call _stock options_ are indeed options on stock, but they are not _compensatory_ stock options awarded for services. In this Guide, and most likely in any conversation you have with an employer, anyone who says “stock options” will be referring to compensatory stock options. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Vesting and Cliffs ​Definition​**Vesting** is the process of gaining full legal rights to something. In the context of compensation, founders, executives, and employees typically gain rights to their grant of equity incrementally over time, subject to restrictions. People may refer to their shares or [stock options](https://www.holloway.com/definitions/stock-options) vesting, or may say that a person is vesting or has fully vested. ​Definition​ In the majority of cases, vesting occurs incrementally over time, according to a **vesting schedule**. A person vests only while they work for the company. If the person quits or is terminated immediately, they get no equity, and if they stay for years, they’ll get most or all of it. Awards of stock, [stock options](https://www.holloway.com/definitions/stock-options), and [RSUs](https://www.holloway.com/definitions/restricted-stock-units-or-rsus) are almost always subject to a vesting schedule. ​Definition​ Vesting schedules can have a **cliff** designating a length of time that a person must work before they vest at all. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### How Options Expire ​Definition​ The **exercise window (or exercise period)** is the period during which a person can buy shares at the [strike price](https://www.holloway.com/definitions/strike-price-or-exercise-price). Options are only exercisable for a fixed period of time, until they expire, typically seven to ten years as long as the person is working for the company. But this window is not always open. ​danger​ **Expiration after termination.** Options can expire after you quit working for the company. Often, the expiration is **90 days** after termination of service, making the options effectively worthless if you cannot [exercise](https://www.holloway.com/definitions/exercise) before that point. As we’ll get into later, you need to understand the costs, [taxes](https://www.holloway.com/g/equity-compensation/sections/taxes-on-isos-and-nsos), and tax [liabilities](https://www.holloway.com/g/equity-compensation/sections/the-amt-trap) of exercise and to plan ahead. In fact, you can find out when you are granted the options, or better yet, before you sign an [offer letter](https://www.holloway.com/definitions/verbal-offer-and-written-offer-and-offer-letter). ​important​ **Longer exercise windows.** Recently (since around 2015) a few companies are finding ways to keep the exercise window open for years after leaving a company, promoting this practice as fairer to employees. Companies with [extended exercise windows](https://github.com/holman/extended-exercise-windows) include Amplitude,[\*](https://amplitude.com/blog/employee-equity-is-broken-heres-our-fix/) Clef,[\*](https://github.com/clef/handbook/blob/master/Hiring%20Documents/Guide%20to%20Your%20Equity.md) Coinbase,[\*](https://blog.coinbase.com/improving-equity-compensation-at-coinbase-8749979409c3) Pinterest,[\*](https://fortune.com/2015/03/23/pinterest-employee-taxes/) and Quora.[\*](https://www.quora.com/Why-do-most-startups-force-employees-to-exercise-their-vested-ISO-options-within-90-days-if-they-leave-rather-than-the-option-to-convert-to-NSOs) However, the 90-day exercise window remains the norm. ​controversy​ **The exercise window debate.** Whether to have extended exercise windows has been debated at significant length. Some believe extended exercise windows are [the future](https://triplebyte.com/blog/extending-stock-option-exercise-window-guide#.12rv7ovrv), arguing that a shorter window makes a company’s success a [punishment](https://stockoptioncounsel.com/blog/nc7go8ivzxb1el5rhv6nltrjan0n2t/2017/3/6) to early employees. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Kinds of Stock Options ​Definition​ Compensatory [stock options](https://www.holloway.com/definitions/stock-options) come in two flavors, **incentive stock options (ISOs)** and **non-qualifying stock options (NQOs, or NQSOs)**. Confusingly, lawyers and the IRS use [several names](https://www.irs.gov/taxtopics/tc427) for these two kinds of stock options, including **statutory stock options** and **non-statutory stock options (or NSOs)**, respectively. In this Guide, we refer to ISOs and NSOs. | Type | Also called | | --- | --- | | Statutory | Incentive stock option, ISO | | Non-statutory | Non-qualifying stock option, NQO, NQSO, NSO | - Companies generally decide to give ISOs or NSOs depending on the legal advice they get. It’s rarely up to the employee which they will receive, so it’s best to know about both. There are pros and cons of each from both the recipient’s and the company’s perspective. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Early Exercise ​Definition​ Sometimes, to help reduce the tax burden on [stock options](https://www.holloway.com/definitions/stock-options), a company will make it possible for option holders to **early exercise (or forward exercise)** their options, which means they can [exercise](https://www.holloway.com/definitions/exercise) even before they vest. The option holder becomes a [stockholder](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder) sooner, after which the [vesting](https://www.holloway.com/definitions/vesting) applies to actual stock rather than options. This will have [tax implications](https://www.holloway.com/g/equity-compensation/sections/83b-elections). ​caution​ However, the company has the right to repurchase the _unvested_ shares, at the price paid or at the [fair market value](https://www.holloway.com/definitions/fair-market-value-or-fmv) of the shares (whichever is lower), if a person quits working for the company. The company will typically repurchase the unvested shares should the person leave the company before the stock they’ve purchased vests. ### Restricted Stock Units While [stock options](https://www.holloway.com/definitions/stock-options) are the most common form of equity compensation in smaller [private companies](https://www.holloway.com/definitions/private-companies), [RSUs](https://www.holloway.com/definitions/restricted-stock-units-or-rsus) have become the most common type of equity award for public and large private companies. Facebook pioneered the use of RSUs as a private company to allow it to avoid having to register as a [public company](https://www.holloway.com/definitions/public-companies) earlier. ​···​ ​Definition​[**Restricted stock units (RSUs)**](https://www.investopedia.com/terms/r/restricted-stock-unit.asp) refer to an agreement by a company to issue an employee shares of stock or the cash value of shares of stock on a future date. Each unit represents one share of stock or the cash value of one share of stock that the employee will receive in the future. (They’re called _units_ since they are neither stock nor [stock options](https://www.holloway.com/definitions/stock-options), but another thing altogether that is contractually linked to the value of stock.) ​Definition​ The date on which an employee receives the shares or cash payment for RSUs is known as the **settlement date**. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Using Promissory Notes to Buy Stock Usually you need the cash to buy shares—maybe more than you can afford to pay at [exercise](https://www.holloway.com/definitions/exercise) time. Another, less common approach to be aware of is for companies to allow the person exercising options to avoid paying the cash up front and instead accept a promise of payment in the future. ​Definition​ A company may accept a **promissory note** to [exercise](https://www.holloway.com/definitions/exercise) compensatory options. Essentially, a promissory note is like giving an “IOU” to the company instead of paying the company cash for shares. The note may either be a **recourse promissory note** or **non-recourse promissory note**. “Non-recourse” means the lender (the company) is prohibited from seeking a deficiency payment from the borrower (the recipient of the stock) personally if they do not pay; they only can foreclose on the property itself (in this case the stock). ​technical​ The tax consequences to the company and the optionee depend on how the note is structured. If the note is non-recourse, for state law purposes the company will consider you an owner of the shares received in exchange for the non-recourse note, but the IRS will consider the shares still an option until the promissory note is paid (which would also affect timing for long-term capital gains). ​technical​ Non-recourse promissory notes can also be used to extend option windows on [stock options](https://www.holloway.com/definitions/stock-options) that are expiring (for example, after 10 years), while not requiring the holder of the options to pay until later, when the stock may be liquid or have higher value. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Less Common Types of Equity While most employee equity compensation takes the form of stock, [stock options](https://www.holloway.com/definitions/stock-options), or [RSUs](https://www.holloway.com/definitions/restricted-stock-units-or-rsus), a complete tour of equity compensation must mention a few less common forms. ​Definition​**Phantom equity** is a type of compensation award that references equity, but does not entitle the recipient to actual ownership in a company. These awards come under a variety of different monikers, but the key to understanding them is knowing that they are really just cash bonus plans, where the cash amounts are determined by reference to a company’s stock. Phantom equity can have significant value, but may be perceived as less valuable by workers because of the contractual nature of the promises. Phantom equity plans can be set up as purely discretionary bonus plans, which is less attractive than owning a piece of something. Two examples of phantom equity are phantom stock and [stock appreciation rights](https://www.holloway.com/definitions/stock-appreciation-rights-or-sars): ​Definition​ A [**phantom stock**](https://www.investopedia.com/articles/stocks/12/introduction-phantom-stock.asp) award is a type of phantom equity that entitles the recipient to a payment equal to the value of a share of the company’s stock, upon the occurrence of certain events. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ## [Tax Basics](https://www.holloway.com/g/equity-compensation/sections/tax-basics)11 minutes, 46 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000052%22%7D) The awarding of equity compensation can give rise to multiple types of taxes for the recipient, including federal and state [income taxes](https://www.holloway.com/definitions/income-tax) and [employment taxes](https://www.holloway.com/definitions/employment-taxes-and-payroll-taxes). [Skip ahead](https://www.holloway.com/g/equity-compensation/sections/taxes-on-equity-compensation) to understand how taxes on equity work, but if you have time, this section gives a technical summary of tax fundamentals, just in case you (like most people!) never really figured out all the numbers on your pay stub. Given the complexity, most taxpayers aren’t aware of how their tax is calculated. It does take up thousands of pages[\*](https://slate.com/news-and-politics/2014/04/how-long-is-the-tax-code-it-is-far-shorter-than-70000-pages.html) of the federal tax code and involves the intricate diversity of state tax law as well.[\*](https://www.govinfo.gov/app/details/USCODE-2016-title26) You don’t need to know every detail, and can rely on software and professionals to determine the tax you owe, but we do suggest understanding the different kinds of taxes, how large they can be, and how each is “triggered” by different events. ​confusion​ For those not already familiar with tax terminology, watch out: Many terms sound like regular English, but they’re not. _[Ordinary income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains)_, _long-term_ and _short-term_, _election_, _qualified small business_, and other phrases have very specific meanings we’ll do our best to spell out. ### Kinds of Income ​Definition​**Income** is the money an individual makes. For tax purposes, there are two main types of income, which are taxed differently. [**Ordinary income**](https://www.investopedia.com/terms/o/ordinaryincome.asp) includes wages, salary, bonuses and interest made on investments. [**Capital gains**](https://www.investopedia.com/terms/c/capital_gains_tax.asp) are the profits an individual makes from selling assets, including stock. One key difference between ordinary income and capital gains is that when capital gains taxes are calculated, consideration is given not just to the sale price of the asset but to the total gain or loss the investment incurred, each outcome having significantly different tax consequences. ​Definition​ Capital gains are classified as long-term or short-term. **Long-term capital gains** are the profits an individual makes from selling assets, such as stock, a business, a house, or land, that were held for more than a year. **Short-term capital gains** are profits from the sale of assets held for less than a year. Although this topic is not without ​paid​ [controversy](https://www.wsj.com/articles/how-should-capital-gains-be-taxed-1425271052), the general idea is, if you are selling something you’ve owned for a long time, you can be taxed at a lower rate. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Federal Taxes ​Definition​**Income tax** is the money paid by individuals to federal, state, and, in some cases, local governments, and includes taxation of [ordinary income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) and [capital gains](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains). Generally, U.S. citizens, residents, and some [foreigners](https://www.irs.gov/individuals/international-taxpayers/nra-withholding) must [file](https://www.irs.gov/pub/irs-pdf/p17.pdf) and pay federal [income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) tax. ​important​ In general, federal tax applies to many [kinds of income](https://www.irs.gov/forms-pubs/about-publication-525). If you’re an employee at a startup, you need to consider four kinds of federal tax, each of which is computed differently. ​confusion​ When it comes to equity compensation, it’s possible that you’ll have to worry about _all of these_, depending on your situation. That’s why we have a lot to cover here: ​Definition​**Ordinary income tax** is the tax on wages or salary [income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains), and short-term investment income. The term **short-term capital gains tax** may be applied to taxes on assets sold less than a year from purchase, but profits from these sales are taxed as [ordinary income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains). For a lot of people who make most of their money by working, ordinary income tax is the biggest chunk of tax they pay. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### State Taxes State tax rates and rules [vary significantly](https://taxfoundation.org/state-individual-income-tax-rates-brackets-2018/). Since federal rates are much higher than state rates, you usually think of federal tax planning first. But you should also know a bit about tax rates in your state. State [long-term capital gains](https://www.holloway.com/definitions/long-term-capital-gains-and-short-term-capital-gains) rates range widely. California has the highest, at **13.3%**; several states have none.[\*](https://www.fool.com/taxes/2014/10/04/the-states-with-the-highest-capital-gains-tax-rate.aspx) ​important​ For this reason, some people even [consider moving](https://www.forbes.com/sites/robertwood/2016/05/17/can-you-avoid-california-taxes-by-moving/) to another state if they are likely to have a windfall gain, like selling a lot of stock after an [IPO](https://www.holloway.com/definitions/initial-public-offering-or-ipo-and-goes-public). ​···​ ## [Taxes on Equity Compensation](https://www.holloway.com/g/equity-compensation/sections/taxes-on-equity-compensation)19 minutes, 29 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000880%22%7D) Equity and taxes interact in complicated ways, and the tax consequences for an employee receiving [restricted stock](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants), [stock options](https://www.holloway.com/definitions/stock-options), or [RSUs](https://www.holloway.com/definitions/restricted-stock-units-or-rsus) are dramatically different. This section will cover these messy details and help you make decisions that reduce the tax burden of your equity compensation. ### 83(b) Elections This section covers one of the most important and complex decisions you may need to make regarding [stock awards](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants) and [stock options](https://www.holloway.com/definitions/stock-options): paying taxes early with an [83(b) election](https://www.holloway.com/definitions/83-b-election). - Generally, [restricted stock](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants) is taxed as [ordinary income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) [_when it vests_](https://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp). - If the stock is in a startup with low value, this may not result in high tax. If it’s been years since the stock was first granted and the company is now worth a lot, the taxes owed could be quite significant. ​Definition​ The Internal Revenue Code, in [Section 83(b)](https://www.law.cornell.edu/uscode/text/26/83), offers taxpayers receiving equity in exchange for work the option to pay taxes on their options before they vest. If qualified, a person can tell the IRS they prefer this alternative in a process called an [**83(b) election**](https://web.archive.org/web/20190905050448/http://acceleratedvesting.com/what-is-an-83b-election-and-when-do-i-make-it-part-1-with-graphic/). Paying taxes early with an 83(b) election can potentially reduce taxes significantly. If the shares go up in value, the taxes owed at [vesting](https://www.holloway.com/definitions/vesting) might be far greater than the taxes owed at the time of receipt. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### 409A Valuations When a person’s stock vests, or they [exercise](https://www.holloway.com/definitions/exercise) an option, the IRS determines the tax that person owes. But if no one is buying and selling stock, as is the case in most startups, then the value of the stock—and thus any tax owed on it—is not obvious. ​Definition​ The **fair market value (FMV)** of any good or property refers to a price upon which the buyer and seller have agreed, when both parties are willing, knowledgeable, and not under direct pressure to carry out the exchange. The fair market value of a company’s stock refers to the price at which a company will issue stock to its employees, and is used by the IRS to calculate how much tax an employee owes on any equity compensation they receive. The FMV of a company’s stock is determined by the company’s most recent 409A valuation. ​Definition​ A [**409A valuation**](https://assets.fenwick.com/legacy/FenwickDocuments/409_Valuations_Stock_Options.pdf) is an assessment [private companies](https://www.holloway.com/definitions/private-companies) are required by the IRS to conduct regarding the value of any equity the company issues or offers to employees. A company wants the 409A to be low, so that employees make more off options, but not so low the IRS won’t consider it reasonable. In order to minimize the risk that a 409A [valuation](https://www.holloway.com/definitions/valuation) is manipulated to the benefit of the company, companies hire independent firms to perform 409A valuations, typically annually or after events like [fundraising](https://www.holloway.com/definitions/fundraising-and-financing). The 409A valuation of employee equity is usually much less than what investors pay for [preferred stock](https://www.holloway.com/definitions/common-stock-and-preferred-stock); often, it might be only a third or less of the preferred stock price. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Taxes on ISOs and NSOs Typically, early to mid-stage companies grant [stock options](https://www.holloway.com/definitions/stock-options), which may be [ISOs or NSOs](https://www.holloway.com/g/equity-compensation/sections/kinds-of-stock-options). - ​danger​When you get [stock options](https://www.holloway.com/definitions/stock-options) and are considering if and when to [exercise](https://www.holloway.com/definitions/exercise), you need to think about the taxes and **when you owe them**. In principle, you need to think about taxes you may incur at three points in time: - at **time of grant** - at **time of exercise** - at **time of sale** - These events trigger ordinary tax (high), [long-term capital gains](https://www.holloway.com/definitions/long-term-capital-gains-and-short-term-capital-gains) (lower), or [AMT](https://www.holloway.com/definitions/alternative-minimum-tax-or-amt) (possibly high) taxes in different ways for [NSOs](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options) and [ISOs](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options). ​Definition​ The taxes at time of [exercise](https://www.holloway.com/definitions/exercise) will depend on the gain between the [strike price](https://www.holloway.com/definitions/strike-price-or-exercise-price) and the [FMV](https://www.holloway.com/definitions/fair-market-value-or-fmv), known as the **spread** or the [**bargain element**](https://web.archive.org/web/20200204074119/http://www.investorwords.com/5414/bargain_element.html). This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### The AMT Trap When it comes to taxes and equity compensation, one scenario is so dangerous we give it its own section. ​danger​ If you have received an [ISO](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options), exercising it may unexpectedly trigger a big [AMT](https://www.holloway.com/definitions/alternative-minimum-tax-or-amt) bill—even before you actually make any money on a sale! If there is a large [spread](https://www.holloway.com/definitions/spread-and-bargain-element) between the [strike price](https://www.holloway.com/definitions/strike-price-or-exercise-price) and the [409A valuation](https://www.holloway.com/definitions/409a-valuation), you are potentially on the hook for an enormous tax bill, even if you can’t sell the stock. This has pushed people into bankruptcy. It also caused Congress to grant a one-time forgiveness, the odds of which happening again are very low. ​Definition​ The catastrophic scenario where exercising [ISOs](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options) triggers a large [AMT](https://www.holloway.com/definitions/alternative-minimum-tax-or-amt) bill, with no ability to sell the stock to pay taxes, is sometimes called the **AMT trap**. This [infamous](https://www.nceo.org/articles/stock-options-alternative-minimum-tax-amt) problem has trapped many employees and [bankrupted](https://web.archive.org/web/20201127234656/http://blog.sfgate.com/dgreenberg/2012/06/22/tax-advice-from-the-dot-com-bubble-beware-of-isos/) people during past dot-com busts. Now more people know about it, but it’s still a significant obstacle to plan around. ​new​ In 2017, Congress passed the [Tax Cuts and Jobs Act](https://en.wikipedia.org/wiki/Tax_Cuts_and_Jobs_Act_of_2017) (TCJA), which increases [AMT](https://www.holloway.com/definitions/alternative-minimum-tax-or-amt) exemptions and their phaseout thresholds. This means fewer people will be affected by AMT in 2018 and later than in prior years.[\*](https://medium.com/@barryjk/the-tax-law-that-is-unintentionally-hammering-silicon-valley-employees-894a7b54ba8a) This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Stock Awards vs. ISOs vs. NSOs Because the differences are so nuanced, what follows is a summary of the taxes on [restricted stock awards](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants), [ISOs](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options), and [NSOs](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options), from an employee’s point of view. - **[Restricted stock awards](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants).** Assuming [vesting](https://www.holloway.com/definitions/vesting), you pay full taxes early with the 83(b) or at vesting: - At grant: - if [83(b) election](https://www.holloway.com/definitions/83-b-election) filed, ordinary tax on [FMV](https://www.holloway.com/definitions/fair-market-value-or-fmv) - none otherwise - At vesting: - none if 83(b) election filed - ordinary tax on FMV of vested portion otherwise - At sale: - [long-term capital gains tax](https://www.holloway.com/definitions/long-term-capital-gains-tax) on gain if held for **1 year** past when taken into [income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) - ordinary tax otherwise (including immediate sale) - **[NSOs](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options).** You pay full taxes at [exercise](https://www.holloway.com/definitions/exercise), and the sale is like any investment gain: - At grant and [vesting](https://www.holloway.com/definitions/vesting): - no tax if granted at (or above) [FMV](https://www.holloway.com/definitions/fair-market-value-or-fmv) - At exercise: - [ordinary income tax](https://www.holloway.com/definitions/ordinary-income-tax-and-short-term-capital-gains-tax) on the amount by which the FMV of the shares received exceeds the [exercise price](https://www.holloway.com/definitions/strike-price-or-exercise-price) - [income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) and [employment tax](https://www.holloway.com/definitions/employment-taxes-and-payroll-taxes) withholding on paycheck - At sale: - [long-term capital gains tax](https://www.holloway.com/definitions/long-term-capital-gains-tax) on gain if held for **1 year** past exercise - [short-term capital gains tax](https://www.holloway.com/definitions/ordinary-income-tax-and-short-term-capital-gains-tax) (ordinary [income tax](https://www.holloway.com/definitions/income-tax) rates) otherwise (this includes immediate sale at exercise) - **[ISOs](https://www.holloway.com/definitions/incentive-and-non-qualifying-and-statutory-and-non-statutory-stock-options).** You might pay less tax at [exercise](https://www.holloway.com/definitions/exercise), but it’s complicated: - At grant and [vesting](https://www.holloway.com/definitions/vesting): - no tax if granted at (or above) [FMV](https://www.holloway.com/definitions/fair-market-value-or-fmv) - At exercise: - **[AMT](https://www.holloway.com/definitions/alternative-minimum-tax-or-amt) tax event** on the [bargain element](https://www.holloway.com/definitions/spread-and-bargain-element) - no ordinary or [capital gains](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) tax - no [income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) or [employment tax](https://www.holloway.com/definitions/employment-taxes-and-payroll-taxes) withholding on paycheck - At sale: - [long-term capital gains tax](https://www.holloway.com/definitions/long-term-capital-gains-tax) if held for **1 year** past exercise and **2 years** past grant date This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Taxes on RSUs If you are awarded [RSUs](https://www.holloway.com/definitions/restricted-stock-units-or-rsus), each unit represents one share of stock that you will be given when the units vest. - Here’s the tax summary for [RSUs](https://www.holloway.com/definitions/restricted-stock-units-or-rsus): - At grant: - no tax - At vesting/delivery: - ordinary tax on current share value - At sale: - [long-term capital gains tax](https://www.holloway.com/definitions/long-term-capital-gains-tax) on gain if held for **1 year** past [vesting](https://www.holloway.com/definitions/vesting) - [short-term capital gains tax](https://www.holloway.com/definitions/ordinary-income-tax-and-short-term-capital-gains-tax) (ordinary [income tax](https://www.holloway.com/definitions/income-tax) rates) otherwise (this includes immediate sale) - ​caution​ When you receive your shares, you are taxed on their value at that time.[\*](http://joewallin.com/2014/09/13/rsus-vs-restricted-stock-vs-stock-options/) If you are an employee, this means you may have to write a check to the company to cover your [income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) and [employment tax](https://www.holloway.com/definitions/employment-taxes-and-payroll-taxes) withholding. Often, for U.S. employees, companies will withhold the tax in the form of shares such that no action is required by the employee at [vesting](https://www.holloway.com/definitions/vesting) time.[\*](https://www.schwab.com/public/eac/resources/articles/rsu_basics.html) - If you receive an RSU when the stock is of little value, you cannot elect to be taxed on the value of that stock when you receive the RSU—you pay taxes at [vesting](https://www.holloway.com/definitions/vesting) time, based on the value of the shares at that time. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Tax Comparison Table #### Table: Comparing Taxes on Types of Equity Compensation This table is a summary of the differences in taxation on types of equity compensation. | | Restricted stock awards | ISOs | NSOs | RSUs | | --- | --- | --- | --- | --- | | _Tax at grant_ | If 83(b) election filed, ordinary tax on FMV. None otherwise. | No tax if granted at FMV. | No tax if granted at FMV. | No tax. | | _Tax at vesting_ | None if 83(b) election filed. Ordinary tax on FMV of vested portion otherwise. | No tax if granted at FMV. | No tax if granted at FMV. | Ordinary tax on current share value. | | _Tax at exercise_ | | AMT tax event on the bargain element. No ordinary or capital gains or employment tax. | Ordinary tax on the bargain element. Income and employment tax. | | | _Tax at sale_ | Long-term capital gains tax on gain if held for **1 year** past when taken into income. Ordinary tax otherwise (including immediate sale). | Long-term capital gains if held for **1 year** past exercise and **2 years** past grant date. Ordinary tax otherwise (including immediate sale). | Long-term capital gains if held for **1 year** past exercise. Ordinary tax otherwise (including immediate sale). | Long-term capital gains tax on gain if held for **1 year** past vesting. Ordinary tax otherwise (including immediate sale). | ### Tax Dangers Because they are so important, we list some costly errors to watch out for when it comes to taxes on equity compensation: - ​danger​ If you are going to file an [83(b) election](https://www.holloway.com/definitions/83-b-election), it must be **within 30 days** of [stock grant](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants) or option [exercise](https://www.holloway.com/definitions/exercise). Often, law firms will take a while to send you papers, so you might only have a week or two. If you miss this window, it could potentially have giant tax consequences, and is essentially an irrevocable mistake—it’s one deadline the IRS won’t extend. When you file, get documentation from the post office as well as a delivery confirmation, and include a self-addressed, stamped envelope for the IRS to send you a return receipt. (Some people are so concerned about this they even ask a friend to go with them to the post office as a witness!) - ​danger​ Watch out for the [AMT trap](https://www.holloway.com/definitions/amt-trap) we’ve already discussed. - ​danger​ If you [exercise](https://www.holloway.com/definitions/exercise) your options, and your [income](https://www.holloway.com/definitions/income-and-ordinary-income-and-capital-gains) had been from consulting rather than employment (1099, not W-2), you will be subject to the [self-employment tax](https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes), which consist of both the employer and the employee side of FICA. In addition to owing the normal [income tax](https://www.holloway.com/definitions/income-tax), this means you will owe the Social Security tax component ( **6.2%**) up to the FICA wage base, and you will owe the Hospital Insurance component ( **2.9%**) on all of your income. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ## [Plans and Scenarios](https://www.holloway.com/g/equity-compensation/sections/plans-and-scenarios)12 minutes, 19 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000001851%22%7D) ### Evaluating Equity Compensation Once you understand the [types of equity](https://www.holloway.com/g/equity-compensation/sections/how-equity-is-granted) and their [tax implications](https://www.holloway.com/g/equity-compensation/sections/taxes-on-equity-compensation), you have many of the tools you need to evaluate an offer that includes equity compensation, or to evaluate equity you currently have in a company. In summary, you have to determine or make educated guesses about several things: - **Equity value.** This can be estimated by the value the company may have in the future, and the number of shares you may own. - **[Percentage ownership](https://www.holloway.com/definitions/percentage-ownership-and-basis-points).** As we’ve mentioned, knowing how many shares of stock or [stock options](https://www.holloway.com/definitions/stock-options) you have is meaningless unless you know the number of [outstanding shares](https://www.holloway.com/definitions/outstanding-shares). What matters is the percentage ownership of the company the shares represent, including the [details](https://www.holloway.com/g/equity-compensation/sections/counting-shares) of how the total is counted. - **Risk.** It is critical to understand [risk](https://www.holloway.com/g/equity-compensation/sections/stages-of-a-startup) in the business and [dilution](https://www.holloway.com/definitions/dilution) to ascertain the possible future value of equity. [This article](https://www.codingvc.com/p/valuing-employee-options) from Leo Polovets provides some additional thoughts. - **[Vesting](https://www.holloway.com/definitions/vesting).** Understand [when](https://www.holloway.com/g/equity-compensation/sections/vesting-and-cliffs) you will receive the equity, as well as whether you’re able to [exercise](https://www.holloway.com/definitions/exercise) stock options (and pay the associated costs and taxes), and whether you can do all this before your [exercise window](https://www.holloway.com/definitions/exercise-window-or-exercise-period) expires. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### What Is Private Stock Worth? We now turn to the question of determining the value of [private company](https://www.holloway.com/definitions/private-companies) stock. We’ve seen how stock in private companies often [can’t be sold](https://www.holloway.com/g/equity-compensation/sections/can-you-sell-private-stock), so its value is [difficult to estimate](https://www.investopedia.com/articles/fundamental-analysis/11/valuing-private-companies.asp). The value of equity you cannot yet sell is a reflection of three major concerns: 1. How well the company is doing now—that is, how profitable it is, or how many customers it is attracting. 2. How well the company will perform in the future. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Can You Sell Private Stock? Ultimately, the value of your equity depends on whether and when you are able to convert it into stock that you sell for cash. With [public companies](https://www.holloway.com/definitions/public-companies), the answer is relatively easy to estimate—as long as there are no restrictions on your ability to sell, you know the current market value of the stock you own or might own. What about [private companies](https://www.holloway.com/definitions/private-companies)? A [liquidity event](https://www.holloway.com/definitions/liquidity-and-exits-and-liquidity-events-and-liquidations) is usually what makes it possible for [shareholders](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder) in a [private company](https://www.holloway.com/definitions/private-companies) to sell their stock. However, individuals may sometimes be able to gain [liquidity](https://www.holloway.com/definitions/liquidity-and-exits-and-liquidity-events-and-liquidations) while a company is still private. ​Definition​ A **secondary market (or secondary sale, or private sale)** transaction is when [private company](https://www.holloway.com/definitions/private-companies) stock [is sold](https://www.cooleygo.com/secondary-sales-of-private-company-stock/) to another private party. This is in contrast to **primary market** transactions, where companies sell directly to investors. Secondary sales are not routine, but they can sometimes occur, such as when an employee sells to an accredited investor who wants to invest in the company. ​Definition​ Shares held by an employee are typically subject to a **right of first refusal (ROFR)** in favor of the company, meaning the employee can’t sell their shares to a third party without offering to sell their shares to the company first. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Stock Option Scenarios The key decisions around [stock options](https://www.holloway.com/definitions/stock-options) are when to [exercise](https://www.holloway.com/definitions/exercise) and, if you can, when to sell. Here we lay out some common scenarios that might apply to you. Considering these scenarios and their outcomes can help you evaluate your position and decide what you should do. - **[Exercise](https://www.holloway.com/definitions/exercise) and hold.** You can write the company a check and pay any taxes on the [spread](https://www.holloway.com/definitions/spread-and-bargain-element). You are then a [stockholder](https://www.holloway.com/definitions/stock-and-shares-and-shareholder-or-stockholder), with a [stock certificate](https://www.holloway.com/definitions/stock-certificates) that may have value in the future. As [discussed](https://www.holloway.com/g/equity-compensation/sections/how-equity-is-granted), you may exercise: - Early, even immediately upon grant. - Before [vesting](https://www.holloway.com/definitions/vesting) (if [early exercise](https://www.holloway.com/definitions/early-exercise-or-forward-exercise) is available to you). - Sometime after vesting. - After leaving the company, as long as the [exercise window](https://www.holloway.com/definitions/exercise-window-or-exercise-period) is open. - ​caution​ Recall that the window is likely to [close soon](https://www.holloway.com/g/equity-compensation/sections/how-options-expire) after you leave a company, often 90 days after termination. - **Wait until [acquisition](https://www.holloway.com/definitions/acquisition-and-sale).** If the company is acquired for a large multiple of the [exercise price](https://www.holloway.com/definitions/strike-price-or-exercise-price), you may then use your options to buy valuable stock. However, as discussed, your shares could be worth next to nothing unless the sale price exceeds the [liquidation overhang](https://www.holloway.com/definitions/liquidation-overhang). - ​caution​ **[Secondary market](https://www.holloway.com/definitions/secondary-market-and-primary-market).** As [discussed](https://www.holloway.com/g/equity-compensation/sections/can-you-sell-private-stock), in some cases it’s possible to [exercise](https://www.holloway.com/definitions/exercise) and sell the stock in a [private company](https://www.holloway.com/definitions/private-companies) directly to a private party. But this generally requires some cooperation from the company and is not something you can always count on. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Summary of Dangers Because of their importance, we’ll wind up with a recap of some of the key dangers we’ve discussed when thinking about equity compensation: - ​danger​ When it comes to equity compensation, details matter! You need to understand the type of [stock grant](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants) or [stock option](https://www.holloway.com/definitions/stock-options) in detail, as well as what it means for your taxes, to know what your equity is worth. - ​danger​ Because details are so important, [professional advice](https://www.holloway.com/g/equity-compensation/sections/seeking-professional-advice) from a tax advisor or lawyer familiar with equity compensation (or both) is often a good idea. Avoid doing everything yourself, but also avoid blindly trusting advisors without having them explain the details to you in a way you understand. - ​danger​ With [stock options](https://www.holloway.com/definitions/stock-options), high [exercise](https://www.holloway.com/definitions/exercise) costs or high taxes, including the [AMT trap](https://www.holloway.com/definitions/amt-trap), may prevent you from exercising your options. If you can’t sell the stock and your [exercise window](https://www.holloway.com/definitions/exercise-window-or-exercise-period) is limited, you could effectively be forced to walk away from your stock options. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ## [Offers and Negotiations](https://www.holloway.com/g/equity-compensation/sections/offers-and-negotiations)29 minutes, 56 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000002337%22%7D) When a company offers any form of equity as part of its compensation package, there is a whole new set of factors for a prospective employee to consider. This chapter will help you prepare for negotiating a job offer that includes equity, covering negotiation tips and expectations, and specific reminders on what you can ask and what is negotiable when it comes to equity. ### Why Negotiation Matters Before accepting any job offer, you’ll want to negotiate [firmly and fairly](https://web.archive.org/web/20190225175428/cefne.com/en/harvard-method-negotiation). You’re planning to devote a lot of your time and sanity to any full-time role; help yourself make sure that this is ​paid​ [what you want](https://hbr.org/2016/12/think-strategically-about-your-career-development). ​confusion​ It’s perfectly natural to be [anxious](https://www.pon.harvard.edu/daily/negotiation-skills-daily/the-impact-of-anxiety-and-emotions-on-negotiations-how-to-avoid-misjudgment-in-negotiation-scenarios/) about negotiations, whether you’re going through this process for the first time or the tenth. There is a lot at stake, and it can be uncomfortable and stressful to ask for things you need or want. Many [people think](https://www.forbes.com/sites/tanyatarr/2017/12/31/here-are-five-negotiation-myths-we-can-leave-behind-in-2017/) negotiating could get the job offer revoked, so they’ll accept their offer with little or no discussion. But remember that negotiations are the first experience you’ll have of working with your new team. If you’re nervous, it can help to remind yourself why it’s important to have these conversations: - Negotiations ask you to focus on what you actually want. What is important to you—personal growth, career growth, impact, recognition, cash, ownership, teamwork? Not being clear with yourself on what your priorities really are is a recipe for dissatisfaction later. - If you aren’t satisfied with the terms of your offer, accepting it without discussion can be tough not just for you but for your new company and colleagues as well. No one wants to take on a hire who’s going to walk away in just a few months when something better comes along. For everyone’s sake, take your time now to consider what you want—and then [ask for it](https://www.earnest.com/blog/how-to-negotiate-a-job-offer/). This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Equal Treatment ​important​ Companies can and should work hard to ensure that all candidates are given [equal treatment](https://rework.withgoogle.com/guides/pay-equity/steps/introduction/) in the hiring process, but inequalities persist.[\*](https://iwpr.org/wp-content/uploads/2020/07/2020-Weekly-Wage-Gap-2020-FINAL.pdf) Workplace disparities in pay and opportunity span race and gender,[\*](https://hdl.handle.net/1813/75722) with research focusing on inequality in the U.S. workplace,[\*](https://www.pewresearch.org/fact-tank/2016/07/01/racial-gender-wage-gaps-persist-in-u-s-despite-some-progress/) executive leadership and its well-documented lack of diversity,[\*](https://aflcio.org/paywatch/company-pay-ratios)[\*](https://fortune.com/2017/06/09/white-men-senior-executives-fortune-500-companies-diversity-data/) and the technology industry.[\*](https://www.eeoc.gov/special-report/diversity-high-tech) Gender bias in negotiation itself is also an issue; many women have been made to feel that they shouldn’t ask for what they deserve.[\*](https://www.newyorker.com/science/maria-konnikova/lean-out-the-dangers-for-women-who-negotiate) More effort is needed to end biases and close the wage gap. All candidates should take the time to understand their worth and the specific value they can add to a company, so that they are fully prepared to negotiate for a better offer. ### General Expectations - Many companies will give some leeway during [negotiations](https://www.holloway.com/g/equity-compensation/sections/negotiation-tips), letting you indicate whether you prefer [higher salary](https://hired.com/blog/candidates/salary-vs-equity-how-decide-whats-right/) or [higher equity](https://www.investopedia.com/articles/personal-finance/041515/equity-vs-salary-what-you-need-know.asp). - Candidates with competing offers almost always have more leverage and get better offers.[\*](https://www.shrm.org/resourcesandtools/hr-topics/employee-relations/pages/using-a-job-offer-as-leverage-is-no-longer-a-big-no-no.aspx) - Salaries at startups are often a bit below what you’d get at an established company, since early on, cash is at a premium. For very early stage startups, risk is higher, offers can be more highly variable, and variation among companies will be greater, particularly when it comes to equity. - The dominant factors [determining equity](https://www.holloway.com/g/equity-compensation/sections/typical-employee-equity-levels) are what funding [stage](https://www.holloway.com/g/equity-compensation/sections/stages-of-a-startup) a company is at, and the role you’ll play at the company. If no funding has been raised, large equity may be needed to get early team members to work for very little or for free. Once significant funding of an A round is in place, most people will take typical or moderately discounted salaries. Startups with seed funding lie somewhere in between. ### Offers ​Definition​ When making a job offer, companies will often give a candidate a **verbal offer** first, to speed things along and facilitate the negotiation, following it with a **written offer** if it seems like the candidate and the company are close to agreement on the terms of the offer. The written offer takes the form of an ​document​ [**offer letter**](https://www.upcounsel.com/employee-offer-letter), which is just the summary sent to the candidate, typically with an expiration date and other details and [paperwork](https://www.holloway.com/g/equity-compensation/sections/documents-and-agreements). Although companies often want you to sign right away to save time and effort, if you’re doing it thoughtfully you’ll also be talking to the company (typically with a hiring manager, your future manager, or a recruiter, or some combination) multiple times before signing. This helps you negotiate details and gives you a chance to get to know the people you could be working with, the company, and the role, so that you can make the best decision for your personal situation. When you are ready to accept the terms of the offer letter, you can go ahead and sign. Things to look for in the [offer letter](https://www.glassdoor.com/blog/how-to-read-offer-letter/) include: This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Offers From Startups Because startups are so much smaller than many established companies, and because they may grow quickly, there are additional considerations worth taking into account when negotiating a job offer from a startup: - **Cash versus equity.** If your [risk tolerance](https://www.investopedia.com/terms/r/risktolerance.asp) is reasonably high, you might ask for an offer with more equity and less cash. If a company begins to do well, it’ll likely “level up” lower salaries (bringing them closer to market average) even if you got more equity up front. On the other hand, if you ask for more cash and less equity, it’s unlikely you’ll be able to negotiate to get more equity later on, since equity is increasingly scarce over time (at least in a successful company!). Entrepreneur and [venture capitalist](https://www.holloway.com/definitions/venture-capital-and-venture-capitalists-or-vcs) [Mark Suster](https://en.wikipedia.org/wiki/Mark_Suster) stresses the need to [level up](https://bothsidesofthetable.com/this-is-how-startups-level-up-after-raising-money-328d17076515) by scaling pay and spending, focusing appropriately at each funding stage. In the very early days of a startup, it’s not uncommon for employees to have higher salaries than the company’s founders.[\*](https://siliconhillslawyer.com/2016/06/23/founder-compensation-cash-equity-liquidity/) ​···​ - **Title.** Negotiating title and exact details of your role early on may not matter as much in a small and growing company, because your role and the roles of others may change a lot, and quickly. It’s more important that you respect the founders and leaders of the company. It’s more important that you feel you are [respected](https://blog.shrm.org/blog/respect-and-trust-top-the-list-of-most-important-employee-job-satisfaction). ### Questions Candidates Can Ask ​important​ It’s important to ask questions when you get an offer that includes any kind of equity. In addition to helping you learn the facts about the equity offer, the process of discussing these details can help you get a sense of the company’s transparency and responsiveness. Here are a few questions you should consider asking, especially if you’re evaluating an offer from a startup or another [private company](https://www.holloway.com/definitions/private-companies): - **[Percentage ownership](https://www.holloway.com/definitions/percentage-ownership-and-basis-points).** - _What percentage of the company do the shares represent?_ - _What set of shares was used to compute that percentage? Is it [outstanding shares](https://www.holloway.com/definitions/outstanding-shares) or [fully diluted](https://www.holloway.com/definitions/fully-diluted)?_ - _What convertible securities are outstanding (convertible notes, SAFEs, or warrants), and how much [dilution](https://www.holloway.com/definitions/dilution) can I expect from their conversion?_ - **[Valuation](https://www.holloway.com/definitions/valuation).** - _What did the last round value the company at? (That is, what is the preferred share price times the total [outstanding shares](https://www.holloway.com/definitions/outstanding-shares)?)_ - _What is the most recent [409A valuation](https://www.holloway.com/definitions/409a-valuation)? When was it done, and will it be done again soon?_ - _What [exit](https://www.holloway.com/definitions/liquidity-and-exits-and-liquidity-events-and-liquidations) valuation will need to be achieved before [common stock](https://www.holloway.com/definitions/common-stock-and-preferred-stock) has positive value (that is, what are the [liquidation](https://www.holloway.com/definitions/liquidity-and-exits-and-liquidity-events-and-liquidations) overhangs)?_ - **[Stock options](https://www.holloway.com/definitions/stock-options).** - _Do you allow [early exercise](https://www.holloway.com/definitions/early-exercise-or-forward-exercise) of my options?_ - _Am I required to [exercise](https://www.holloway.com/definitions/exercise) my options within 90 days after I leave or am terminated? Does the company extend the [exercise window](https://www.holloway.com/definitions/exercise-window-or-exercise-period) of the options of employees that depart?_ This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Typical Employee Equity Levels Compensation data is highly situational. What an employee receives in equity, cash, and benefits depends on the role they’re filling, the sector they work in, where they and the company are located, and the possible value that specific individual may bring to the company. Any compensation data out there is hard to come by. Companies often pay for this data from [vendors](https://www.advanced-hr.com/products-overview), but it’s usually not available to candidates. For startups, a variety of data is easier to come by. We give some overview here of early-stage Silicon Valley tech startups; many of these numbers are not representative of companies of different kinds across the country: - ​important​ One of the best ways to tell what is reasonable for a given company and candidate is to look at offers from companies with similar profiles on [AngelList](https://angel.co/). The [**AngelList salary data**](https://angel.co/salaries) is extensive. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Typical Startup Advisor Equity Levels ​Definition​**Advisors** are people with extensive or unique experience who help a company in a formal or informal capacity. It is common for startups to bring on advisors with a recognized name, specific background or skills, or access to a network. Sometimes advisors act as mentors to founders.\* Startup advisor compensation is usually partly or entirely via equity. Typical equity levels vary depending on the value the advisor brings, the maturity of the company, and the level of their involvement, which can vary from occasional phone-calls or introductions all the way up to being a kind of part-time, hands-on member of the team. Because advisors may not add value for as many years as an employee, a common [vesting schedule](https://www.holloway.com/definitions/vesting-schedule) for an advisor is two years with a three-month [cliff](https://www.holloway.com/definitions/cliff). Advisor grants also typically have a longer [exercise window](https://www.holloway.com/definitions/exercise-window-or-exercise-period) post termination of service, and will usually have [single trigger](https://www.holloway.com/definitions/accelerated-vesting-and-single-trigger-and-double-trigger) acceleration on an [acquisition](https://www.holloway.com/definitions/acquisition-and-sale), because no one expects advisors to stay on with a company once it’s acquired. One commonly used framework for compensation for advisors is the [FAST Agreement](https://fi.co/fast) from the Founder Institute, an accelerator that’s been involved with over 4500 companies. Their approach is to recommend compensation based on the level of engagement (from monthly meetings to hands-on projects and help with networking) and the maturity of the company (from just an idea to growth stage, which would likely mean post-Series A): This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Negotiation Tips ​···​ When negotiating a job offer, companies will always ask you what you want for compensation, and you should always be [cautious](https://www.chicagobooth.edu/review/how-answer-one-toughest-interview-questions) about answering. If you name the lowest number you’ll accept, you can be pretty sure the company’s not going to exceed it, at least not by much. ​caution​ Asking about salary expectations is a normal part of the hiring process at most companies, but asking about **salary history** has been banned in a growing number of states, cities, and counties.[\*](https://www.hrdive.com/news/salary-history-ban-states-list/516662/) These laws attempt to combat pay disparity[\*](https://www.nytimes.com/2018/02/16/business/economy/salary-history-laws.html) among women and minorities by making it illegal for companies to ask about or consider candidates’ current or past compensation when making them offers. Make sure you understand the laws relevant to your situation. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Offer and Negotiation Dangers To wind up our discussion of offers and negotiations, here are some key dangers and mistakes to watch out for: - ​danger​ Do not accept an offer of stock or shares without also asking for the exact number of total shares (or, equivalently, the exact percentage of the company those shares represent). It’s quite common for some companies to give offers of stock or options and tell you only the number of shares. Without the percentage, the number of shares is meaningless. Not telling you is a deeply unfair practice. A company that refuses to tell you even when you’re ready to sign an offer is likely giving you a very poor deal. - ​caution​ If you’re looking at an offer, work out whether you can and should [early exercise](https://www.holloway.com/definitions/early-exercise-or-forward-exercise), and what the cost to [exercise](https://www.holloway.com/definitions/exercise) and tax will be, before accepting the offer. - ​danger​ If you join a startup right as it raises a new round, and don’t have the chance to [exercise](https://www.holloway.com/definitions/exercise) right away, they may potentially issue you the options with the low [strike price](https://www.holloway.com/definitions/strike-price-or-exercise-price), but the [409A valuation](https://www.holloway.com/definitions/409a-valuation) of the stock will have gone up. This means you won’t be able to [early exercise](https://www.holloway.com/definitions/early-exercise-or-forward-exercise) without a large tax bill. In fact, it might not be financially feasible for you to exercise at all. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ## [Documents and Agreements](https://www.holloway.com/g/equity-compensation/sections/documents-and-agreements)8 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000125%22%7D) This section covers a few kinds of documents you’re likely to see as you negotiate a job offer and sign on to a company. It’s not exhaustive, as titles and details vary. - When you are considering your offer, make sure you have all of the documents you need from the company: - Your ​document​ [offer letter](https://www.upcounsel.com/employee-offer-letter), which will detail salary, benefits, and equity compensation. - An ​document​ [Employee Innovations Agreement](https://recruit.smashfly.com/SmashFlyMedia/Docs/12250/12250_168_United%20States%20-%20EIPIA%20English%20%28Rev%2014%20FEBRUARY%202017%29%202%20pages.pdf), Proprietary Information and Inventions Assignment Agreement, or similar, concerning intellectual property. - If you have equity compensation, at some point—possibly weeks or months after you’ve joined—you should get a Summary of [Stock Grant](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants), Notice of [Stock Option](https://www.holloway.com/definitions/stock-options) Grant, or similar document, detailing your grant of stock or options, along with all details such as number of shares, type of options, grant date, [vesting](https://www.holloway.com/definitions/vesting) commencement date, and [vesting schedule](https://www.holloway.com/definitions/vesting-schedule). It will come with several other documents, which may be exhibits to that agreement: - ​document​ [Stock Option Agreement](https://www.upcounsel.com/stock-option-agreement) - ​document​ [Stock Plan](https://www.upcounsel.com/equity-incentive-plan) (sometimes called a Stock Option Plan, or [Stock Award](https://www.holloway.com/definitions/restricted-stock-award-and-restricted-stock-and-stock-awards-and-stock-grants) Plan, or Equity Incentive Plan) - ​document​ [Code Section 409A Waiver and Release](https://www.lawinsider.com/clause/code-section-409a-waiver-and-release) (sometimes part of the Stock Option Agreement) - If you are exercising your options, you should also see paperwork to assist with that purchase: - ​document​ [Exercise Agreement](https://www.upcounsel.com/option-exercise-agreement) - Instructions and template for [early exercise](https://www.holloway.com/definitions/early-exercise-or-forward-exercise) and ​document​ [83(b) election](https://www.irs.gov/pub/irs-drop/rp-12-29.pdf), if applicable. This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ## [Further Reading](https://www.holloway.com/g/equity-compensation/sections/further-reading)5 minutes, 49 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000143%22%7D) The resources here are a small subset of the full set of resources cited in the Guide to Equity Compensation, selected for their breadth, notability, or depth on specific issues. ### General Resources - Mark P. Cussen, Investopedia, [_Introduction To Incentive Stock Options_](https://www.investopedia.com/articles/stocks/12/introduction-incentive-stock-options.asp), updated 2017 - Alex MacCaw, [_An Engineer’s Guide to Stock Options_](https://blog.alexmaccaw.com/an-engineers-guide-to-stock-options/), 2013 - Andy Rachleff, Wealthfront, [_The 15 Crucial Questions About Stock Options_](https://www.wealthfront.com/blog/stock-options-15-crucial-questions/), 2018 - Mary Russell, [Stock Option](https://www.holloway.com/definitions/stock-options) Counsel, [_Startup Equity Standards: A Guide for Employees_](https://www.slideshare.net/StockOptionCnsl/startup-standards-stock-option-counsel), 2014 This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Considerations for Founders - Matthew Bartus, Cooley GO, [_Option Grants: Fully Diluted or Issued and Outstanding_](https://www.cooleygo.com/option-grants-fully-diluted-issued-outstanding/) - Jay Bhatti, Business Insider, [_How Startups Should Deal With Cliff Vesting For Employees_](https://www.businessinsider.com/everything-you-need-to-know-about-cliff-vesting-2011-5), 2011 - Tahir J. Naim, Fenwick, [_Section 409A Valuations and Stock Option Grants for Start-up Technology and Life Science Companies_](https://assets.fenwick.com/legacy/FenwickDocuments/409_Valuations_Stock_Options.pdf) - Babak Nivi, Venture Hacks [_The Option Pool Shuffle_](https://venturehacks.com/option-pool-shuffle) (and [table of equity](https://venturehacks.com/option-pool-shuffle#market) ranges), 2017 This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Considerations for Candidates and Employees - Anonymous, [_What I Wish I’d Known About Equity Before Joining A Unicorn_](https://gist.github.com/yossorion/4965df74fd6da6cdc280ec57e83a202d), 2017 - Atish Davda, Inc, [_5 Questions You Should Ask Before Accepting a Startup Job Offer_](https://www.inc.com/atish-davda/5-questions-you-should-ask-before-taking-a-start-up-job-offer.html), 2014 - Julia Evans, [_Things you should know about stock options before negotiating an offer_](https://jvns.ca/blog/2015/12/30/do-the-math-on-your-stock-options/), 2015 - Guy Kawasaki, [_Nine Questions to Ask a Startup_](https://guykawasaki.com/nine_questions_/), 2006 This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Types of Equity Compensation - Jeron Paul, Capshare, [_RSUs vs. Options: Why RSUs (Restricted Stock Units) Could be Better Than Stock Options At Your Private Company_](https://web.archive.org/web/20190916150411/www.capshare.com/blog/rsus-vs-options/), 2016 - Andy Rachleff, Wealthfront, [_Stock Options vs. Restricted Stock Units (RSUs): What’s the Difference?_](https://www.wealthfront.com/blog/stock-options-versus-rsu/), 2014 - Mary Russell, [Stock Option](https://www.holloway.com/definitions/stock-options) Counsel, [_Early Expiration of Startup Stock Options - Part 3 - Examples of Good Equity Design by Company Stage_](https://stockoptioncounsel.com/blog/early-expiration-of-startup-stock-options-part-3-examples-of-good-startup-equity-design-by-company-stage/2017/8/11), 2017 - Joe Wallin, The Startup Law Blog, [_Incentive Stock Options vs. Nonqualified Stock Options_](https://web.archive.org/web/20200414125747/http://www.startuplawblog.com/2013/05/15/incentive-stock-options-vs-nonqualified-stock-options/), 2013 This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Taxes - Steven Ayre, [Accelerated Vesting](https://www.holloway.com/definitions/accelerated-vesting-and-single-trigger-and-double-trigger), [_What Is An 83(b) Election and When Do I Make It?_](https://web.archive.org/web/20190905050448/http://acceleratedvesting.com/what-is-an-83b-election-and-when-do-i-make-it-part-1-with-graphic/), 2013 - Mark P. Cussen, Investopedia, [_How Restricted Stock and Restricted Stock Units (RSUs) Are Taxed_](https://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp) - Barry Kramer, ​login​ [_The Tax Law that is (Unintentionally) Hammering Silicon Valley Employees_](https://medium.com/@barryjk/the-tax-law-that-is-unintentionally-hammering-silicon-valley-employees-894a7b54ba8a), 2015 - Joshua Levy and Joe Wallin, The Startup Law Blog, [_Immediately Exercisable ISOs: The Problems_](https://thestartuplawblog.com/immediately-exercisable-isos-the-problems/), 2015 This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Vesting and Expiration of Stock Options - Babak Nivi, Venture Hacks, [_How to make a cap table_](https://venturehacks.com/cap-table), 2007 - Mary Russell, [Stock Option](https://www.holloway.com/definitions/stock-options) Counsel, [_Can the Company Take Back My Vested Shares?_](https://stockoptioncounsel.com/blog/standards-ownership-canthecomanytakebackmyvestedshares), 2017 - Mary Russell, [Stock Option](https://www.holloway.com/definitions/stock-options) Counsel, [_Early Expiration of Startup Stock Options - Part 1 - A $1 Million Problem_](https://stockoptioncounsel.com/blog/nc7go8ivzxb1el5rhv6nltrjan0n2t/2017/3/6), 2017 - Mary Russell, [Stock Option](https://www.holloway.com/definitions/stock-options) Counsel, [_Early Expiration of Startup Stock Options - Part 2 -The Full 10-Year Term Solution_](https://stockoptioncounsel.com/blog/early-expiration-of-startup-stock-options-part-2-the-full-10-year-term-solution/2017/3/28), 2017 This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ### Negotiation - Robby Grossman, [_Negotiating Your Startup Job Offer_](https://robbygrossman.com/2013/negotiating-your-startup-job-offer), 2013 - Sheelah Kolhatkar, The New Yorker, [_Lean Out: The Dangers for Women who Negotiate_](https://www.newyorker.com/magazine/2017/11/20/the-tech-industrys-gender-discrimination-problem), 2017 - Deepak Malhotra, Harvard Business Review, [15 Rules for Negotiating a Job Offer](https://hbr.org/2014/04/15-rules-for-negotiating-a-job-offer), 2014 - [CEFNE (Center for Study and Training in Business Negotiation)](https://web.archive.org/web/20190225175428/cefne.com/en/harvard-method-negotiation) ### Forms and Tools - ​tool​ [TLDR Stock Options](https://equity.ltse.com/calculators/tldr-stock-options) and [OwnYourVenture](https://altline.sobanco.com/own-your-venture/) are simulators illustrating equity calculations and [dilution](https://www.holloway.com/definitions/dilution) - Orrick, ​document​ [Startup Forms: Equity Compensation](https://www.orrick.com/Total-Access/Tool-Kit/Start-Up-Forms/Equity-Compensation) ## [Disclaimer](https://www.holloway.com/g/equity-compensation/sections/disclaimer) [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000172%22%7D) _This Guide and all associated comments and discussion do not constitute legal or tax advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. The author(s) expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this Guide or associated content._ ## [Credits](https://www.holloway.com/g/equity-compensation/sections/credits)11 links [give this chapter](https://www.holloway.com/s/purchase-book?refParams=%7B%22sectionChunkSid%22%3A%22equity-compensation.root.s-0000000297%22%7D) Many thanks to all [contributors](https://github.com/jlevy/og-equity-compensation/graphs/contributors) to this Guide and those who have given detailed feedback, including [Julia Evans](https://twitter.com/b0rk), [George Grellas](https://twitter.com/grellas), [Chris McCann](https://twitter.com/mccannatron), [Leo Polovets](https://twitter.com/lpolovets), [Srinath Sridhar](https://www.linkedin.com/in/srinath-sridhar-0a16705), [Andy Sparks](https://twitter.com/SparksZilla), and [David Weekly](https://twitter.com/dweekly), and to the many [commentators on Hacker News](https://news.ycombinator.com/item?id=10880726). The original authors are [Joshua Levy](https://twitter.com/ojoshe) and [Joe Wallin](https://twitter.com/joewallin). ### Please Help! This Guide is a living publication, imperfect but improving. If you have an idea or contribution that might improve this Guide, please add suggestions in the margins. We gladly credit all contributors. ## License [​](https://creativecommons.org/licenses/by-sa/4.0/) ​ This is a preview. Buy it now for lifetime access to expert knowledge, including future updates. [Buy ►](https://www.holloway.com/checkout/index.html?product=equity-compensation) [Learn More ►](https://www.holloway.com/b/equity-compensation) ?L 10.51M