A younger me wanted to start a new business. I had identified a great niche, I had a supplier in mind, and I felt confident I could be successful, just not by myself. I needed help and I wasn’t in a position to spend time or money on hiring. I decided I’d look for a partner. I spoke with several people, and we got close to an agreement multiple times. However, my desire to protect my interest in the company often clashed with potential partner’s desire for solid returns. Back then I didn’t know about the options that would have given us all what we wanted, and I didn’t ask for help on that problem. Consequently, the business was done before it started.
What Are Stock Options?
Stock options give employees the right to buy company shares at a set price (known as the strike price) after a specific vesting period. They don’t receive shares upfront, but if the company’s value rises, they can exercise those options and potentially benefit from that growth. Stock options carry risk. If your startup’s value dips below the strike price, the options lose some appeal.
Advantages
- Motivates employees to work toward increasing company value.
- Often requires less immediate cost to you as the employer.
Drawbacks
- Employees may feel disappointed if the share price never goes above the strike price.
- Some folks find the exercise process confusing.
What About RSUs?
Restricted stock units (RSUs) give employees shares or the value of shares once they hit vesting milestones. Instead of buying these shares, employees receive them outright at no purchase cost. RSUs might feel simpler to your team because there’s no need to pay a strike price. Yet taxes can become an issue, as RSUs are taxed as soon as they vest.
Advantages
- Employees get a direct stake without needing to pay anything upfront.
- RSUs have less downside risk compared to options.
Drawbacks
- There can be higher immediate tax implications when they vest.
- Employees don’t have the same optionality if the share price drops.
ISOs and NSOs Are Not the Same Instrument
“Stock option” covers two different tax animals. An incentive stock option, or ISO, is available only to employees, is capped at $100,000 of stock value becoming exercisable in any calendar year, and generates no ordinary income at exercise. If the holder keeps the shares for more than two years from grant and more than one year from exercise, the entire gain is long-term capital gain. If the shares are sold before either holding period runs, that is a disqualifying disposition: the spread becomes ordinary income in the year of the sale and only the remaining gain, if any, is capital gain. The other catch is the alternative minimum tax. Under Internal Revenue Code section 56(b)(3) the spread at exercise is added to alternative minimum taxable income as an AMT adjustment, and employees have been hit with large AMT bills on shares they could not sell. That adjustment does not apply if the shares are sold in the same calendar year as exercise. Starting in 2026 the AMT exemption phases out more steeply for high earners, so year-end exercise planning matters more than it did.
A non-qualified stock option, or NSO, can go to anyone, including advisors and contractors. The spread between the strike price and fair market value at exercise is ordinary income, subject to withholding for employees and reportable for contractors. NSOs are simpler and more flexible; ISOs are more tax-favourable and more constrained. Most plans authorise both and specify per grant.
The 83(b) Election
If a founder or employee receives restricted stock, or exercises an option early while the shares are still subject to a repurchase right, Internal Revenue Code section 83(b) allows an election to be taxed on the value at the time of transfer rather than as the shares vest. At an early-stage company where that value is close to the purchase price, the tax on the election is often near zero, and all later appreciation is capital gain. The election must be filed with the IRS within thirty days of the transfer, and the deadline is not extendable. Since 2025 the IRS provides Form 15620 for the election, which can be filed on paper or electronically through an IRS online account; a copy still goes to the company. A missed 83(b) is one of the most expensive and most common startup mistakes, and it cannot be fixed after the fact.
409A Valuations
Internal Revenue Code section 409A requires that a stock option be granted with a strike price at least equal to the fair market value of the underlying stock on the grant date. Granting below fair market value can make the option subject to immediate income inclusion plus an additional twenty percent tax and interest, and the person who pays that is the option holder. Private companies establish fair market value through an independent 409A valuation, which creates a presumption of reasonableness if it is no more than twelve months old and no material event has occurred since. In practice: get a 409A before the first grant, refresh it annually, and refresh it after any priced financing.
Single-Trigger and Double-Trigger Acceleration
Vesting terms should say what happens on an acquisition. Single-trigger acceleration vests some or all of an award when the change of control closes. Double-trigger acceleration vests only if the change of control happens and the holder is terminated without cause or resigns for good reason within a stated window, commonly nine to eighteen months, with twelve months the figure most often used. Buyers generally dislike single-trigger acceleration because it removes the retention value of the equity they are paying for, and heavy single-trigger terms surface as a price or escrow issue in diligence. Where a plan provides acceleration at all, double-trigger is the norm for employees, and limited single-trigger is sometimes negotiated for founders and executives. Many grants below the senior level carry no acceleration, so the first question is whether to offer it, not which kind.
Common Concerns
“Will my team appreciate these perks?”
Equity shows you value your people. If your plan is clear and fair, most staff members see it as an opportunity.
“Should I worry about taxes?”
Taxes differ depending on the type of option and how long the shares are held. An ISO can defer ordinary income until sale if the holding periods described above are met, an NSO creates ordinary income at exercise, and RSUs create a tax event at vesting. An accountant or attorney can help you structure a plan that works best for your team.
“Could I lose control of the company?”
These equity plans dilute ownership slightly. But if you set sensible vesting schedules and clarity around how many shares you offer, you can maintain control while rewarding those who help grow your startup.
How to Decide
Choosing between stock options and RSUs depends on your goals, the stage of your startup, and how your team feels about risk. If you want to inspire employees to push for a higher valuation, stock options might spark motivation. If you prefer something more straightforward, RSUs might fit better.
Practical Steps
- Review Your Budget: Think about how each plan affects cash flow, taxes, and future fundraising.
- Seek Legal Guidance: Different jurisdictions have varied rules for issuing options or RSUs. A lawyer can pinpoint the right path.
- Communicate Clearly: Your team should know exactly what these terms mean. Offer an FAQ or hold a small Q&A session to walk them through details.
Equity compensation can feel like a murky world. Yet with the right approach, you can harness these tools to reward key contributors and strengthen your company’s future. The founder I met eventually chose a balanced approach—offering options to certain employees and RSUs to others. He found that matching each person’s preference kept morale high without triggering confusion. You can craft a similar plan that aligns with your vision, budget, and team culture. And by doing so, you’ll help your employees share in the growth they help create.