Startup equity compensation means giving employees, advisors and contractors a stake in the company instead of, or on top of, cash. Early on, two instruments matter: restricted stock while the share price is nominal, and stock options once the company has a 409A valuation. This guide covers the whole system and links to a detailed answer on each topic.
Key takeaways
- Founders and the very first hires usually get restricted stock. Later employees get stock options.
- Grants are priced at fair market value: par value at formation, then the 409A value.
- Four-year vesting with a one-year cliff is standard for everyone, founders included.
- Promise a number of shares, not a percentage, and issue it promptly.
What types of equity can a startup give?
| Restricted stock (RSA) | Stock option (ISO / NSO) | RSU | |
| What it is | Shares issued up front, subject to buyback until vested | The right to buy shares later at a fixed price | A promise to deliver shares when vested |
| Who usually gets it | Founders, first hires and advisors before a 409A | Employees (ISOs); advisors and contractors (NSOs) | Employees of late-stage companies |
| What the recipient pays | Fair market value at issuance | The exercise price, when they exercise | Nothing |
Stock appreciation rights and phantom stock exist but are rare at early-stage companies. See RSUs vs Stock Options and NSO vs ISO.
Who should get which?
- Founders: restricted stock at formation, purchased at par value.
- First hires before a 409A: restricted stock.
- After the first 409A: ISOs for US employees, NSOs for everyone else.
- Advisors and contractors: restricted stock early on, NSOs later.
See Restricted Stock.
How big should the option pool be?
Most companies reserve 10% to 20% of fully diluted shares, depending on the hiring plan, and resize it at each priced round. See Employee Option Pool and Employee Stock Option Plan.
How does vesting work?
Time-based vesting is the standard: four years with a one-year cliff, then monthly. Performance-based vesting is the exception. See Vesting Schedule.
Do I need an 83(b) election?
Anyone receiving unvested restricted stock should consider one, within 30 days of issuance. See 83(b) Election.
When do I need a 409A?
Before your first option grant, then every 12 months and after a priced round. See 409A Valuation.
How is equity taxed?
It depends on the type of equity and the moment: grant, vesting, exercise or sale. Recipients should talk to a tax advisor. See How to Value Startup Stock.
What happens when someone leaves, or the company is sold?
People keep vested equity and lose the rest, and vested options have a limited exercise window. In a sale, equity is handled under the merger agreement, plus any acceleration. See Leaving the Company and Stock Options in an Acquisition.
Is promised equity the same as issued equity?
No. Nothing is owned until the board approves the grant and the agreement is signed. See Promising vs Issuing Equity.
What is Westaway’s default equity setup?
- 10,000,000 authorized shares at $0.00001 par value
- Founders buy restricted stock at par, with four-year vesting, a one-year cliff and an 83(b) election
- An option pool adopted at incorporation, typically 1,000,000 shares
- Restricted stock for first hires until the first 409A, then ISOs for US employees and NSOs for everyone else
Related: Stock Grant · Stock Option Grant · Employee Stock Option Plan · Cap Table Management
