The Complete Startup Equity & Compensation Guide (2025)

Executive Summary

Equity compensation is the currency of startups. From founder shares to employee stock options, understanding how equity works is essential for everyone in the startup ecosystem—founders allocating ownership, employees evaluating offers, and executives negotiating packages.

This comprehensive guide covers everything you need to know about startup equity:

  • Founder equity: Restricted stock, 83(b) elections, and co-founder vesting
  • Stock options: ISOs vs NSOs, strike prices, and exercise strategies
  • Vesting: Standard schedules, cliffs, and acceleration provisions
  • Tax planning: Capital gains optimization, AMT management, and QSBS
  • Special situations: Acquisitions, IPOs, and secondary sales

Whether you're receiving your first equity grant or designing compensation packages, this guide provides the foundation you need.

Part I: Founder Equity

Founder Stock Basics

What is founder stock?

Founder stock is common stock issued to company founders at formation, typically at a nominal price ($0.0001 to $0.001 per share). This stock represents the founders' ownership stake before any outside investment.

Common stock vs. preferred stock:

Feature Common Stock Preferred Stock
Who receives it Founders, employees Investors
Voting rights Yes (typically 1 vote per share) Yes (often as-converted basis)
Dividends Discretionary Usually cumulative
Liquidation preference Last in line First in line (1x, 2x, etc.)
Conversion N/A Converts to common
Anti-dilution protection No Yes (usually)

Typical founder allocations:

At formation, founders divide 100% of the common stock. There's no single "right" split, but considerations include:

  • Original idea contribution
  • Technical vs. business expertise
  • Full-time vs. part-time commitment
  • Capital contribution
  • Domain expertise and network

Common splits include:

  • Solo founder: 100%
  • Equal co-founders: 50/50 or 33/33/34
  • Lead founder + co-founder: 60/40 or 70/30
  • Founding team (3+): Varies widely

Important: Founder stock should ALWAYS be subject to vesting. See "Founder Vesting Schedules" below.

83(b) Elections: The Most Important Tax Decision for Founders

What is an 83(b) election?

An 83(b) election allows you to pay taxes on restricted stock NOW (at grant) instead of later (as it vests). Named after Section 83(b) of the Internal Revenue Code.

Why file an 83(b) election?

Without an 83(b) election:

  • You pay ordinary income tax on stock as it vests
  • Tax is based on fair market value at each vesting date
  • If the company grows, you pay taxes on increasingly valuable stock
  • Tax rate: Up to 37% (ordinary income)

With an 83(b) election:

  • You pay ordinary income tax on stock when granted
  • Tax is based on fair market value at grant (usually very low for founders)
  • Future appreciation taxed as capital gains when you sell
  • Tax rate: 20% (long-term capital gains) for appreciation

The math:

Without 83(b):

  • Grant: 1M shares at $0.001 FMV → $0 tax
  • Year 1 vesting: 250K shares at $1.00 FMV → $250K ordinary income → ~$92,500 tax
  • Year 2-4 vesting: Similar tax events at higher FMVs
  • Total: Potentially hundreds of thousands in taxes as you vest

With 83(b):

  • Grant: 1M shares at $0.001 FMV → $1,000 ordinary income → ~$370 tax
  • Vesting: $0 tax (already paid at grant)
  • Sale: All appreciation taxed at long-term capital gains rate (20%)

For detailed calculations and filing instructions, see our 83(b) Election Form Guide.

The 30-day deadline:

You MUST file your 83(b) election within 30 calendar days of receiving restricted stock. This deadline is absolute—no extensions, no exceptions.

When NOT to file 83(b):

  • Stock already has high FMV (large tax bill upfront)
  • High risk company will fail (you'd pay tax on worthless stock)
  • You can't afford the tax bill
  • You received RSUs (not eligible for 83(b))
  • You received unexercised stock options (83(b) doesn't apply)

Founder Vesting Schedules

Why do founders need vesting?

Vesting protects co-founders and investors from a founder leaving early and keeping their full equity stake. Without vesting:

  • A co-founder could leave after 6 months with 50% of the company
  • Investors won't fund companies with unvested founders
  • Creates misaligned incentives

Standard founder vesting:

Most startups use 4-year vesting with a 1-year cliff:

  • 4-year vesting period: Full ownership after 4 years of service
  • 1-year cliff: No shares vest until 12 months of service
  • Monthly vesting after cliff: 1/48th of shares vest each month

Example:

  • Total shares: 1,000,000
  • Month 1-11: 0 shares vested
  • Month 12 (cliff): 250,000 shares vest (25%)
  • Month 13+: ~20,833 shares vest each month
  • Month 48: All 1,000,000 shares vested

Cliff considerations for co-founders:

For co-founders who've been working together before incorporation:

  • Consider credit for time already worked (e.g., start vesting 6 months in)
  • Or use shorter cliff (6 months instead of 12 months)
  • Document the rationale

Acceleration provisions:

Acceleration allows shares to vest early under certain circumstances:

Single trigger acceleration:

  • Shares accelerate upon a single event (usually change of control/acquisition)
  • Example: 50% of unvested shares accelerate if company is acquired
  • Good for founders, concerning for acquirers

Double trigger acceleration:

  • Requires TWO events for acceleration
  • Typically: Change of control AND termination without cause
  • Example: 100% acceleration if acquired AND fired within 12 months
  • More founder-friendly while acceptable to acquirers
  • Industry standard for executive agreements

What happens if a founder leaves?

If a founder leaves before fully vested:

  • Unvested shares are forfeited (returned to company)
  • Company typically has right to repurchase unvested shares at original price
  • Vested shares remain with departing founder
  • May be subject to right of first refusal on sale

Part II: Employee Equity — Stock Options

Understanding Stock Options

What is a stock option?

A stock option is the right (but not obligation) to buy company stock at a fixed price (the "strike price" or "exercise price") for a specified period.

Key terms:

Term Definition
Grant When you receive the option
Strike/Exercise Price Price you pay to buy shares
Vest When you earn the right to exercise
Exercise When you buy the shares
Fair Market Value (FMV) Current value of shares
Spread FMV minus strike price (your gain)
Expiration When the option expires if not exercised

Example:

  • Grant: 10,000 options at $1.00 strike price
  • After 2 years: 5,000 options vested, FMV now $5.00
  • You exercise 5,000 options: Pay $5,000 (5,000 × $1.00)
  • You now own shares worth $25,000 (5,000 × $5.00)
  • Your gain (spread): $20,000

ISO vs NSO: The Critical Comparison

Stock options come in two types: Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs/NQSOs). The differences are entirely about taxes.

Incentive Stock Options (ISOs)

Tax treatment:

  • No ordinary income tax at exercise (if you hold the shares)
  • Pay only long-term capital gains when you sell (if holding requirements met)
  • Subject to Alternative Minimum Tax (AMT) at exercise

Holding period requirements:

  • Must hold shares for 2+ years after grant date AND
  • Must hold shares for 1+ year after exercise date
  • If both met: All gains taxed as long-term capital gains (20%)
  • If not met: "Disqualifying disposition" — spread taxed as ordinary income

Eligibility:

  • Only employees (not contractors, advisors, or board members)
  • Must be granted under shareholder-approved stock option plan
  • Exercise price must equal or exceed FMV at grant

Annual limit:

  • $100,000 limit on ISO value that can vest in any calendar year
  • Calculated using grant-date FMV × shares vesting that year
  • Options exceeding limit automatically convert to NSOs

90-day exercise window:

  • Must exercise within 90 days of employment termination
  • Or ISO converts to NSO (losing favorable tax treatment)

Non-Qualified Stock Options (NSOs)

Tax treatment:

  • Ordinary income tax at exercise on the spread (FMV - strike price)
  • Company withholds taxes at exercise (similar to salary)
  • Capital gains tax on appreciation after exercise
  • No AMT implications

Eligibility:

  • Anyone: Employees, contractors, advisors, board members
  • No shareholder approval required for grant
  • No limit on grant amounts

Exercise window:

  • Typically 10 years from grant
  • May extend post-termination (company discretion)

Side-by-Side Comparison Table

Feature ISO NSO
Tax at exercise None (but AMT may apply) Ordinary income on spread
Tax at sale (if qualified) Long-term capital gains only Capital gains on post-exercise appreciation
Holding requirements 2 years from grant, 1 year from exercise None
AMT impact Yes (spread is AMT preference item) No
Eligible recipients Employees only Anyone
Annual limit $100K vesting per year No limit
Post-termination exercise 90 days (or loses ISO status) Flexible (company sets)
Withholding at exercise None Yes (like payroll)

Decision Tree: When to Use ISOs vs NSOs

Grant ISOs when:

  • Recipient is an employee
  • Recipient likely to hold shares long-term
  • Total ISO value vesting per year is under $100K
  • Want to attract talent with tax-advantaged equity

Grant NSOs when:

  • Recipient is a contractor, advisor, or board member
  • Need flexibility on exercise windows
  • ISO annual limit already exceeded
  • Company wants tax deduction at exercise

From the recipient's perspective:

ISOs are generally better IF you can:

  • Afford to hold shares for 1+ year after exercise
  • Manage the AMT implications
  • Exercise while spread is relatively small

NSOs may be preferable IF you:

  • Want immediate liquidity (exercise and sell same day)
  • Can't afford the AMT hit
  • Are leaving the company and need extended exercise period

Part III: Exercise Strategies

Early Exercise

What is early exercise?

Early exercise means exercising options BEFORE they vest. You purchase the unvested shares, which remain subject to vesting restrictions.

Why early exercise?

  1. Start capital gains holding period early: Clock starts at exercise, not vesting
  2. Exercise at low FMV: If company is early-stage, spread is minimal
  3. File 83(b) election: Lock in low tax basis, convert all future gains to capital gains
  4. Avoid AMT on ISOs: If spread is zero/minimal, no AMT implications

Requirements for early exercise:

  • Company must permit early exercise in option agreement
  • Must have cash to purchase shares
  • Should file 83(b) election within 30 days

Risks of early exercise:

  • Pay for shares that may never vest (if you leave)
  • Company may fail (lose purchase price)
  • Ties up capital in illiquid investment

Example:

  • Grant: 100,000 options at $0.10 strike, FMV $0.10
  • Early exercise: Pay $10,000 for 100,000 shares
  • File 83(b): $0 taxable income (FMV = strike price)
  • 4 years later, sell at $10/share: $990,000 long-term capital gain
  • Tax: ~$198,000 (20% LTCG)

Without early exercise (regular exercise at vesting):

  • Assume FMV at vesting averages $5/share
  • Ordinary income at each vesting: $4.90/share × 25,000 shares × 4 years = $490,000
  • Tax on ordinary income: ~$181,300 (37%)
  • PLUS capital gains on sale: $500,000 × 20% = $100,000
  • Total tax: ~$281,300

Savings with early exercise: ~$83,000

Standard Exercise (Wait Until Vested)

Most common approach: Wait until options vest, then decide whether to exercise.

Considerations:

Cash requirement: You need cash to pay the strike price (and taxes for NSOs)

  • 10,000 shares × $2.00 strike = $20,000 needed

Tax timing:

  • ISOs: No regular tax at exercise, but AMT may apply
  • NSOs: Ordinary income tax due at exercise

Decision framework:

  1. How much cash do I need?
  2. What's the current spread (FMV - strike)?
  3. For ISOs: What's my AMT exposure?
  4. How confident am I in the company's future?
  5. How long until I can sell (liquidity)?

Exercise at Exit (Same-Day Sale)

What is same-day sale?

Exercise options and sell shares on the same day (or within a short window), typically at an acquisition or IPO.

How it works at acquisition:

  1. Company is acquired for $X per share
  2. Your options are exercised at strike price
  3. You immediately receive acquisition proceeds
  4. Net cash = (acquisition price - strike price) × shares

Tax implications:

  • ISOs (disqualifying disposition): Spread taxed as ordinary income (didn't hold 1+ year)
  • NSOs: Spread taxed as ordinary income (normal treatment)

When same-day sale makes sense:

  • Acquisition scenario (forced liquidity event)
  • IPO with immediate sale
  • Can't afford to exercise and hold
  • Want to capture gains without cash outlay

Cashless Exercise

What is cashless exercise?

A broker-assisted exercise where you exercise options and immediately sell enough shares to cover:

  • Strike price
  • Taxes owed
  • Brokerage fees

Example:

  • 10,000 vested options, $2 strike price
  • Current FMV: $20/share
  • Spread: $18/share
  • Total spread: $180,000

Cashless exercise:

  • Sell ~1,500 shares to cover $20,000 strike price
  • Sell additional shares to cover taxes (~$66,600 for NSO)
  • Keep remaining ~7,500 shares
  • Net result: ~7,500 shares without any cash outlay

Pros: No cash required Cons: Fewer shares retained, triggers immediate tax event

Post-Termination Exercise Windows

Standard window: 90 days after employment ends

What happens:

  • After leaving, you have limited time to exercise vested options
  • If you don't exercise, options expire worthless
  • For ISOs: Must exercise within 90 days or they convert to NSOs

Extended exercise windows (trend):

Many startups now offer extended post-termination exercise windows:

  • 1 year, 3 years, or even 10 years to exercise after leaving
  • Provides flexibility for departing employees
  • Note: ISOs automatically convert to NSOs after 90 days

Why extended windows matter:

  • Employee may not have cash to exercise within 90 days
  • FMV may be high (large cash + tax burden)
  • Company may still be years from liquidity

Part IV: Equity Grant Mechanics

Option Pools

What is an option pool?

A portion of authorized shares reserved for future employee equity grants. Typically created at company formation and expanded at each funding round.

Standard sizing:

Stage Typical Pool Size
Formation 10-15%
Seed 10-15%
Series A 15-20%
Series B+ 10-15% refresh

Pre-money vs. post-money pool:

Pre-money pool: Pool comes out of founders' ownership BEFORE investor money

  • Investor owns $X / ($X + pre-money) = their percentage
  • Founders absorb dilution from pool

Post-money pool: Pool comes out of everyone's ownership AFTER investment

  • Dilutes everyone proportionally
  • More founder-friendly (rare)

Example:

  • Pre-money valuation: $8M
  • Investment: $2M at $10M post-money (20% for investor)
  • 15% option pool (pre-money)

Pre-money pool:

  • Investor: 20%
  • Option pool: 15%
  • Founders: 65%

Post-money pool:

  • Investor: 17% (20% × 85%)
  • Option pool: 12.75% (15% × 85%)
  • Founders: 70.25%

Negotiating pool size: VCs typically want larger pools (more buffer for hires). Founders want smaller pools (less dilution). Negotiate based on actual hiring needs.

409A Valuations

What is a 409A valuation?

An independent appraisal of your company's common stock fair market value, required to set option strike prices.

Why it matters:

  • IRS Section 409A requires options to be granted at FMV
  • If strike price < FMV: Severe tax penalties for recipients
  • 409A valuation provides "safe harbor" protection

When you need one:

  • Before granting first stock options
  • After material events (funding, major contract, significant growth)
  • At least every 12 months
  • After any event that could significantly change value

How valuations work:

Independent valuation firm analyzes:

  • Recent financing transactions
  • Comparable company analysis
  • Discounted cash flow models
  • Market conditions
  • Liquidation preferences (reduces common stock value)

Cost: $2,000-$10,000+ depending on company complexity

Key output: FMV per share of common stock (your strike price)

Strike Price Setting

Basic rule: Strike price must equal or exceed FMV at grant date

Timing considerations:

  • Grant options right AFTER 409A is completed (lowest defensible price)
  • Avoid granting right before known funding event (FMV will increase)
  • Board should approve grants on specific dates

Discounts for common stock:

Common stock is typically worth less than preferred stock because:

  • No liquidation preference
  • No anti-dilution protection
  • Limited voting rights
  • Illiquidity

Typical discount: 50-80% discount to preferred stock price (early stage)

Example:

  • Series A price: $2.00 per preferred share
  • 409A valuation: $0.50 per common share (75% discount)
  • Employee strike price: $0.50

Grant Documentation

Standard documents for option grants:

  1. Stock Option Plan: Board and shareholder-approved plan governing all grants
  2. Stock Option Agreement: Individual agreement for each grant specifying shares, price, vesting
  3. Exercise Notice: Form to submit when exercising options
  4. Stock Purchase Agreement: Agreement executed upon exercise

Key terms in option agreement:

  • Number of shares
  • Type (ISO or NSO)
  • Strike price
  • Vesting schedule
  • Exercise period
  • Post-termination exercise window
  • Early exercise provisions (if any)

Part V: Vesting Structures

Standard Vesting

The 4-year, 1-year cliff structure:

This is the industry standard:

  • Total vesting period: 4 years
  • Cliff: 1 year (no shares vest until 12 months)
  • After cliff: Monthly or quarterly vesting

Why this structure?

  • 4 years aligns with typical early employee tenure
  • 1-year cliff ensures minimum commitment before equity earned
  • Monthly vesting after cliff provides ongoing incentive

Vesting schedule example:

Month Cumulative Vesting Notes
1-11 0% Pre-cliff
12 25% Cliff vests
13 27.08% Monthly vesting begins
24 50% 2-year mark
36 75% 3-year mark
48 100% Fully vested

Variations:

  • 3-year vesting: Common for senior hires, later-stage companies
  • 5-year vesting: Sometimes used for founders
  • 6-month cliff: Common for founders or senior executives
  • No cliff: Rare, sometimes for executives with existing track record

Acceleration Provisions

Single trigger acceleration:

Shares accelerate upon a single event, typically:

  • Change of control (acquisition)
  • IPO
  • Specific company milestone

Example: "50% of unvested shares accelerate upon change of control"

Pros:

  • Ensures reward for employees in acquisition scenario
  • Aligns interests toward exit

Cons:

  • Acquirer may not want to hire employees with no unvested equity (no retention)
  • Can complicate M&A negotiations

Double trigger acceleration:

Requires TWO events:

  1. Change of control, AND
  2. Involuntary termination (fired without cause or resignation for good reason)

Example: "100% of unvested shares accelerate if, within 12 months following a change of control, the holder is terminated without cause"

Why double trigger is preferred:

  • Employees protected if acquiring company doesn't want them
  • Acquirer can retain employees who want to stay (equity continues vesting)
  • Most investor-friendly acceleration structure

"Good reason" resignation triggers typically include:

  • Material reduction in compensation
  • Material change in job duties
  • Relocation beyond X miles
  • Material breach of employment agreement

Performance Vesting

What is performance vesting?

Shares vest upon achievement of specific milestones rather than (or in addition to) time-based vesting.

Common performance metrics:

  • Revenue targets
  • Customer acquisition milestones
  • Product launches
  • Profitability targets
  • Fundraising completion

Example structure:

  • 50% time-based vesting (4-year standard)
  • 50% performance-based (vests upon $10M ARR)

Pros:

  • Aligns incentives with company goals
  • Rewards high performers more than time-servers

Cons:

  • Harder to value (accounting complexity)
  • May create perverse incentives
  • Less certainty for employees

Clawback Provisions

What are clawbacks?

Provisions that allow the company to recover vested equity under certain circumstances.

Common clawback triggers:

  • Termination for cause (fraud, misconduct)
  • Violation of non-compete/non-solicit agreements
  • Breach of confidentiality
  • Detrimental conduct after departure

How clawbacks work:

  • Company has right to repurchase vested shares at lower of FMV or original price
  • Or company can cancel unvested options
  • May require return of proceeds from prior sales

Negotiating clawbacks:

  • Narrow the definition of "cause" triggering clawback
  • Add time limits (clawback expires after X years)
  • Limit to truly egregious conduct

Part VI: Executive Compensation

Executive Equity Packages

Typical grant sizes by role (as % of fully diluted cap):

Role Seed Stage Series A Series B+
CEO (hired) 5-10% 3-5% 1-3%
CTO (hired) 2-4% 1-2% 0.5-1%
CFO 1-2% 0.5-1% 0.25-0.5%
VP Engineering 1-2% 0.5-1% 0.25-0.5%
VP Sales 0.5-1.5% 0.25-0.75% 0.1-0.3%

Note: Founders typically have much larger stakes (20-50%+ combined at seed).

Refresher grants:

After initial equity vests, companies issue additional grants ("refreshers") to maintain retention:

  • Annual refreshers common at later stages
  • Typically vest over 4 years (no cliff for executives)
  • Size: 25-50% of original grant per year

Sign-on grants:

Large initial grants to attract senior talent:

  • Competitive with public company RSU packages
  • May include accelerated vesting on first tranche
  • Consider sign-on cash bonus if significant equity risk

Severance and Golden Parachutes

Executive severance packages:

Typical terms for C-suite involuntary termination (without cause):

  • 6-12 months base salary continuation
  • Pro-rata bonus for the year
  • Accelerated vesting (single or double trigger)
  • COBRA continuation (6-12 months)

Change of control provisions:

  • Double trigger acceleration (standard)
  • Additional cash severance if terminated in connection with acquisition
  • Potential "golden parachute" payments

280G implications (Golden Parachute Tax):

If change-of-control payments exceed 3× the executive's average compensation:

  • Executive faces 20% excise tax on "excess parachute payments"
  • Company loses tax deduction on those payments

Mitigation strategies:

  • Gross-up provisions (company pays executive's excise tax)
  • Modified single-trigger (accelerate just under 280G limit)
  • Section 280G shareholder approval (for private companies)

Deferred Compensation (409A Plans)

What is nonqualified deferred compensation (NQDC)?

Arrangements allowing executives to defer compensation beyond what's permitted in qualified plans (401k, etc.).

Common uses:

  • Defer bonus into future years
  • Defer salary above 401k limits
  • Create supplemental retirement benefits

409A compliance requirements:

  • Timing of deferral election
  • Restrictions on distribution
  • Designation of payment events
  • No acceleration of payments

Penalties for 409A violations:

  • Immediate inclusion of deferred amounts in income
  • 20% additional tax penalty
  • Interest from original deferral date

Phantom Equity and SARs

Phantom equity (Phantom Stock):

Cash-based compensation that mirrors equity value without actual stock:

  • Employee receives cash bonus equal to appreciation in company value
  • No actual shares issued
  • No shareholder status

When used:

  • LLCs (complex to issue actual equity)
  • Companies wanting to limit shareholders
  • International employees (equity tax complications)

Stock Appreciation Rights (SARs):

Similar to phantom equity:

  • Right to receive cash equal to stock appreciation
  • No exercise payment required
  • Cash settlement at vesting/exercise

Part VII: Tax Planning

Capital Gains Optimization

Long-term vs. short-term capital gains:

Holding Period Tax Treatment Federal Rate
< 1 year Short-term (ordinary income) Up to 37%
> 1 year Long-term capital gains 0%, 15%, or 20%

Net Investment Income Tax (NIIT):

  • Additional 3.8% tax on investment income for high earners
  • Applies if AGI > $200K (single) or $250K (married)
  • Total top rate: 23.8% (20% + 3.8%)

Holding period strategies:

  1. Start the clock early: Early exercise + 83(b) starts holding period at exercise
  2. Time your sales: Wait for 1-year holding period before selling
  3. For ISOs: Meet both 2-year from grant AND 1-year from exercise requirements

Qualified Small Business Stock (QSBS)

What is QSBS?

Under Section 1202 of the Internal Revenue Code, gains from selling QSBS may be 100% excluded from federal tax (up to $10M or 10× your cost basis).

Requirements:

  • C corporation with gross assets under $50M at grant
  • Stock acquired at original issuance (not secondary purchase)
  • Held for at least 5 years
  • Company in qualified trade or business (most tech qualifies)

Exclusion amounts:

  • Stock acquired before Sept 28, 2010: 50% exclusion
  • Stock acquired 2010-2015: 75-100% exclusion
  • Stock acquired after Sept 27, 2010: 100% exclusion

Example:

  • Founder stock cost basis: $1,000
  • Sale price: $5,000,000
  • Federal QSBS exclusion: 100% ($5M)
  • Federal tax: $0 (instead of ~$1,000,000)

Note: State tax treatment varies. California does NOT recognize QSBS exclusion.

Alternative Minimum Tax (AMT) Management

What is AMT?

A parallel tax system designed to ensure high-income taxpayers pay minimum taxes despite deductions.

How ISO exercise triggers AMT:

  • When you exercise ISOs, the spread (FMV - strike) is an AMT "preference item"
  • This adds to your AMT income
  • May push you into AMT territory

AMT calculation simplified:

  1. Calculate regular taxable income
  2. Add back AMT preference items (including ISO spread)
  3. Subtract AMT exemption
  4. Calculate AMT at 26%/28% rates
  5. Pay the GREATER of regular tax or AMT

AMT exemption (2025):

  • Single: ~$85,700
  • Married filing jointly: ~$133,300
  • Phase-out at higher incomes

AMT planning strategies:

  1. Exercise in low-income years: Reduce other income in exercise year
  2. Spread exercises across years: Don't exercise all at once
  3. Exercise when spread is low: Early-stage company, immediately after 409A
  4. Same-day sale: Sell immediately (disqualifying disposition, no AMT)
  5. Track AMT credit carryforward: AMT paid creates credit for future years

State Tax Considerations

High-tax states:

  • California: 13.3% top rate, no QSBS recognition
  • New York: 10.9% top rate (NYC adds more)
  • New Jersey: 10.75% top rate

No income tax states:

  • Texas, Florida, Washington, Nevada, Wyoming, Tennessee, South Dakota

Timing of state residence:

Important: Moving states BEFORE exercise can save significant taxes.

  • Exercise options AFTER establishing residence in no-tax state
  • Plan at least 6-12 months in advance
  • Document your move (driver's license, voter registration, etc.)
  • "Source state" rules may still apply for some compensation

California-specific issues:

  • CA taxes based on where services were performed
  • Even if you move to TX before exercise, CA may claim portion
  • Allocation based on CA vs. non-CA work days during vesting

Part VIII: Special Situations

Startup Acquisition

What happens to your equity in an acquisition?

Scenario 1: Cash acquisition

  • All shares converted to right to receive cash
  • Options typically cashed out (acquisition price - strike price)
  • Unvested options may be accelerated (depends on plan/agreement)

Scenario 2: Stock-for-stock acquisition

  • Your shares convert to acquirer's shares
  • Conversion ratio based on deal terms
  • Options may convert to acquirer options or cash out

Scenario 3: Mix of cash and stock

  • Proportional treatment based on deal structure

What happens to unvested equity?

Depends on:

  1. Acquisition agreement terms: May provide for acceleration or assumption
  2. Your employment agreement: Double trigger acceleration provisions
  3. Option plan provisions: Change of control definitions

Common outcomes:

  • Assumed: Your options convert to acquirer options (same vesting continues)
  • Accelerated: Some or all unvested shares vest immediately
  • Cancelled: Unvested options cancelled, cash paid for vested options only

IPO

What happens to equity at IPO?

  • Company goes public, stock becomes tradeable
  • Your options and shares remain, now worth public market value
  • Can sell shares (subject to lockup and insider rules)

Lock-up periods:

  • 180 days typical (can't sell during this period)
  • Protects stock price from insider selling pressure
  • Applies to officers, directors, significant shareholders

10b5-1 plans:

Pre-arranged trading plans that allow insiders to sell without insider trading concerns:

  • Set up during "open window" when you don't have material nonpublic information
  • Specify dates/amounts to sell in advance
  • Creates defense against insider trading allegations

Insider trading restrictions:

  • Cannot trade while in possession of material nonpublic information
  • Quarterly "blackout periods" before earnings announcements
  • Window-based trading policies

Secondary Sales

What are secondary sales?

Sales of private company shares to third parties before an exit event.

Types of secondary transactions:

  • Tender offers: Company-facilitated sale to specific buyer
  • Direct secondary: Negotiate sale to interested buyer
  • Secondary funds: Funds that specialize in buying private company shares

Company approval requirements:

  • Most stock agreements require company consent for transfers
  • Right of first refusal (company can buy shares at same price)
  • Board approval often required

Pricing considerations:

  • Private company shares typically sell at 20-50% discount to latest round
  • Illiquidity discount reflects lack of public market
  • Buyer may want information rights, board observer seat

Tax implications:

  • Long-term capital gains if held > 1 year
  • May affect QSBS eligibility (selling less than all shares)
  • Check 83(b) election status for cost basis

Company Failure

What happens to equity if the company fails?

Stock options:

  • Unexercised options expire worthless
  • No tax consequences (nothing to deduct)
  • If you exercised and paid cash: See worthless stock below

Stock (including exercised options):

Worthless stock deduction:

  • Can claim capital loss when stock becomes worthless
  • Loss = cost basis (what you paid for shares)
  • Worthless = no liquidating distribution AND no reasonable expectation of value

83(b) election implications:

  • If you filed 83(b) and paid tax, you cannot recover those taxes
  • Your cost basis (what you paid) is deductible as capital loss
  • The taxes paid on the 83(b) income are gone

Example:

  • Paid $10,000 for shares, filed 83(b), paid ~$3,700 tax on $10,000 income
  • Company fails, shares worthless
  • Deduction: $10,000 capital loss (offset gains or $3K/year ordinary income)
  • The $3,700 tax paid: Not recoverable

Glossary of Key Terms

Term Definition
83(b) Election IRS election to recognize income on restricted stock at grant rather than vesting
409A Valuation Independent appraisal of common stock fair market value
AMT Alternative Minimum Tax—parallel tax system affecting ISO exercises
Cliff Period before any equity vests (typically 1 year)
Double Trigger Acceleration requiring both change of control and termination
Early Exercise Exercising options before they vest
FMV Fair Market Value—current value of shares
ISO Incentive Stock Option—tax-advantaged option for employees
LTCG Long-Term Capital Gains—gains on assets held > 1 year
NSO/NQSO Non-Qualified Stock Option—standard option without ISO tax benefits
Option Pool Shares reserved for future equity grants
QSBS Qualified Small Business Stock—potentially tax-free gains
RSU Restricted Stock Unit—promise of stock upon vesting
Single Trigger Acceleration upon single event (usually change of control)
Spread Difference between FMV and strike price
Strike Price Price at which options can be exercised
Vesting Process of earning ownership rights over time

Checklists

For Founders Receiving Restricted Stock

  • [ ] Understand your vesting schedule (typically 4 years, 1-year cliff)
  • [ ] File 83(b) election within 30 days of receiving stock
  • [ ] Send copy of 83(b) to company
  • [ ] Attach copy of 83(b) to tax return
  • [ ] Track cost basis for future capital gains calculation
  • [ ] Understand acceleration provisions in your agreement
  • [ ] Document any founder agreement / equity split rationale

For Employees Receiving Stock Options

  • [ ] Determine option type (ISO or NSO)
  • [ ] Understand vesting schedule
  • [ ] Know your strike price and current FMV (spread)
  • [ ] If early exercise available: Consider whether to use it
  • [ ] If early exercising: File 83(b) election within 30 days
  • [ ] Understand post-termination exercise window
  • [ ] Calculate cash needed to exercise
  • [ ] For ISOs: Estimate AMT impact before exercising
  • [ ] Track holding periods for tax purposes

For Executives Negotiating Equity Packages

  • [ ] Benchmark grant size against market (% of fully diluted)
  • [ ] Negotiate vesting terms (shorter cliff, acceleration)
  • [ ] Understand double trigger acceleration provisions
  • [ ] Review 280G implications (golden parachute tax)
  • [ ] Negotiate extended post-termination exercise window
  • [ ] Consider sign-on cash to offset equity risk
  • [ ] Review change-of-control definitions carefully
  • [ ] Understand company's 409A valuation and timing
  • [ ] Get commitment for refresher grants in writing

Related Resources

From Promise Legal:

External Resources:

  • IRS Form 15620 (83(b) Election): https://www.irs.gov/pub/irs-pdf/f15620.pdf
  • IRS Section 83 Guidance: https://www.irs.gov/pub/irs-pdf/p525.pdf
  • Section 409A (Deferred Compensation): https://www.irs.gov/retirement-plans/section-409a-nonqualified-deferred-compensation-plans
  • QSBS Overview: https://www.irs.gov/publications/p550

Get Legal Help

Equity compensation has significant financial and tax implications.

Promise Legal helps founders and executives with:

  • Equity structuring and founder agreements
  • 83(b) election preparation and filing
  • Stock option plan design and administration
  • Executive compensation negotiations
  • Tax planning for equity compensation
  • M&A due diligence and equity treatment

Schedule a consultation or email us at [email protected].

Disclaimer: This guide is provided for informational purposes only and does not constitute legal or tax advice. Equity compensation involves complex legal and tax considerations that vary based on individual circumstances. You should consult with qualified legal and tax advisors before making decisions about equity compensation. Promise Legal assumes no liability for any damages arising from use of this resource.

Last Updated: January 9, 2026

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