Employee stock options
Equity compensation is a powerful tool for attracting and retaining talent. But it comes with complex legal, tax, and accounting requirements that founders must understand.
Key takeaways
- →Establish 409A-compliant equity incentive plan
- →Set standard vesting schedules (4-year, 1-year cliff)
- →Document exercise windows and expiration terms
- →Communicate grant terms clearly to employees
Start with a proper plan
Don't issue equity ad hoc. Establish a formal equity incentive plan approved by your board and, if required, shareholders. The plan sets the rules: eligible participants, types of awards (ISOs, NSOs, RSUs), vesting schedules, exercise procedures. This is foundational infrastructure.
409A valuations are not optional
You need an independent 409A valuation to set strike prices. Using an arbitrary value creates tax penalties for employees and legal exposure for the company. Get valuations when you start issuing options and update after funding rounds or material business changes.
Standard vesting protects everyone
The typical structure: 4-year vesting with 1-year cliff. This means employees earn 25% after year one, then monthly thereafter. The cliff ensures commitment before equity transfers. Document vesting in grant agreements and explain to employees what happens if they leave.
Communicate clearly and consistently
Equity is confusing for many employees. Provide grant agreements, a summary of key terms, and (ideally) modeling tools showing potential value at various exit scenarios. Set expectations about exercise windows, tax implications, and what happens at acquisition or IPO.
Got questions?
Every business is different. Let's discuss how these principles apply to your specific situation.