Startup Employee Equity Guide: Everything You Need to Know

You got a job offer with equity. Congratulations—and also, be careful.

Startup equity is complicated. This guide covers everything employees need to know before signing.

Types of Equity Compensation

Stock Options (ISOs and NSOs)

The right to buy shares at a set price (strike price).

ISOs (Incentive Stock Options):

• Only for employees (not contractors)
• Favorable tax treatment if you hold 2+ years
• Limited to $100K/year vesting (by value)
• Must exercise within 90 days of leaving

NSOs (Non-Qualified Stock Options):

• For anyone (employees, contractors, advisors)
• Taxed as ordinary income when exercised
• No holding period requirements
• No annual limit

RSUs (Restricted Stock Units)

A promise to receive shares when they vest. No purchase required.

Key differences from options:

• No strike price—you just get shares
• Taxed as income when they vest
• More common at later-stage companies
• Simpler to understand

Restricted Stock

Actual shares granted upfront, but with restrictions.

Usually for founders, not employees. Requires 83(b) election.

Key Terms You Must Understand

Strike Price

The price you pay to exercise options.

Profit per Share = Sale Price - Strike Price

Lower strike = more profit. Strike is set by 409A valuation.

Vesting Schedule

How you earn equity over time.

Standard: 4-year vesting with 1-year cliff

| Period | What Happens | |--------|--------------| | Months 0-11 | Nothing vests | | Month 12 | 25% vests (the "cliff") | | Months 13-48 | ~2% vests monthly | | Month 48 | 100% vested |

If you leave at month 6, you get nothing. Leave at month 18, you keep ~31%.

Fully Diluted Shares

Total shares including:

• All issued common stock
• All preferred stock (as-converted)
• All outstanding options
• Unissued option pool

This is the denominator for your ownership percentage.

Liquidation Preference

Investors get paid first in an exit.

If investors have $10M in preferred stock with 1x liquidation preference:

• Company sells for $12M → Investors get $10M, common shareholders split $2M
• Company sells for $8M → Investors get $8M, common shareholders get $0

Evaluating an Equity Offer

Information to Request

Ask for these numbers:

1. Number of options offered
2. Strike price (or expected range)
3. Total fully diluted shares outstanding
4. Latest company valuation (409A and preferred)
5. Vesting schedule
6. Option type (ISO vs NSO)
7. Exercise window after leaving

Calculate Your Ownership

Ownership % = Your Options / Fully Diluted Shares

Example:

• Options: 10,000
• Fully diluted: 10,000,000
• Ownership: 0.1%

Estimate Potential Value

Value at Exit = Ownership % × Exit Valuation × (1 - Dilution)

But adjust for:

• Future dilution (20-50% per round)
• Liquidation preferences
• Probability of success

The "Discounted Value" Method

Given most startups fail, discount your equity:

| Scenario | Probability | Multiple | |----------|-------------|----------| | Total loss | 60% | 0x | | Modest exit | 25% | 1-2x | | Good exit | 12% | 5-10x | | Home run | 3% | 20x+ |

Expected value = Sum(Probability × Value)

A 0.1% stake worth $1M on paper might have expected value of $100-200K.

Exercise Decisions

When Options Vest

You have the right to exercise (buy) vested options.

Reasons to exercise early:

• Lock in lower tax treatment (ISOs)
• Start long-term capital gains clock
• You believe company will succeed

Reasons to wait:

• Conserve cash
• Reduce risk (company might fail)
• Options are valuable even unexercised

The 90-Day Window

Critical: Most companies require you to exercise within 90 days of leaving.

If you have 50,000 vested options at $2 strike:

• Cost to exercise: $100,000
• Plus taxes on the "bargain element"

Many employees forfeit options because they can't afford to exercise.

Ask about extended exercise windows (some companies offer 7-10 years).

83(b) Election

If you exercise unvested options (early exercise), you can file an 83(b) election to:

• Pay taxes now on current value
• Convert future gains to long-term capital gains

Must file within 30 days of exercise. Consult a tax advisor.

Tax Implications

ISOs (Incentive Stock Options)

| Event | Tax | |-------|-----| | Grant | None | | Exercise | AMT may apply | | Sale (qualifying) | Long-term capital gains | | Sale (disqualifying) | Ordinary income + STCG |

Qualifying disposition: Sell 2+ years from grant, 1+ year from exercise.

NSOs (Non-Qualified Stock Options)

| Event | Tax | |-------|-----| | Grant | None | | Exercise | Ordinary income on spread | | Sale | Capital gains on appreciation |

Spread = Fair Market Value - Strike Price

You owe ordinary income tax on the spread at exercise, even if you can't sell.

RSUs

| Event | Tax | |-------|-----| | Grant | None | | Vesting | Ordinary income on full value | | Sale | Capital gains on appreciation |

RSUs are taxed as income when they vest. Many employees are surprised by the tax bill.

Red Flags in Equity Offers

🚩 Watch out for:

• Won't disclose fully diluted shares
• Unusually long vesting (over 4 years)
• Very short exercise window (under 90 days)
• High liquidation preferences (over 1x participating)
• No clear path to liquidity
• Strike price already very high
• No 409A valuation

Questions to Ask

Before accepting:

1. "What's the total number of fully diluted shares?"
2. "What's the current 409A valuation?"
3. "What's the exercise window if I leave?"
4. "Are these ISOs or NSOs?"
5. "What's the company's current runway?"
6. "What liquidation preferences do investors have?"
7. "Has the company done any secondary sales?"

Common Mistakes

1. Overvaluing Equity

Most startup equity is worth $0. Don't take a huge salary cut for paper value.

Rule of thumb: Value equity at 10-20% of "paper value" when comparing offers.

2. Not Understanding Dilution

Your 0.5% today will be 0.25% after Series B. Plan for 50%+ dilution.

3. Ignoring Exercise Costs

10,000 options at $5 strike = $50,000 cash + taxes needed to exercise.

4. Missing the 90-Day Window

If you can't afford to exercise when you leave, your vested options may expire worthless.

5. Not Filing 83(b)

If you early exercise, you have 30 days to file 83(b). No extensions. Miss it and face severe tax consequences.

Calculate Your Equity Value

Use our tools:

• Equity Calculator - Model exit scenarios
• Dilution Simulator - See future round impact
• True Hourly Rate - Include equity in compensation

Key Takeaways

1. Know your numbers - ownership %, fully diluted shares, strike price
2. Expect dilution - 50%+ through future rounds
3. Understand exercise costs - options aren't free
4. Watch the exercise window - 90 days goes fast
5. Discount heavily - most equity is worth $0
6. Get tax advice - ISOs, NSOs, and 83(b) are complex

Related Reading:

• Cap Table 101
• Understanding Dilution
• The Mathematics of Founder Equity