Startup Equity Agreements: A Plain-English Guide

Equity Can Be Valuable — But Only If You Understand It

Startup equity is often a significant part of compensation, but the terms can be complex. Understanding your equity agreement helps you evaluate whether the offer is genuinely valuable or mostly symbolic.

Types of Equity

• Incentive Stock Options (ISOs): Tax-advantaged options available only to employees. You pay the exercise price to buy shares, and favorable tax treatment applies if you hold them long enough.
• Non-Qualified Stock Options (NSOs/NQSOs): Available to employees, contractors, and advisors. Taxed as ordinary income on exercise.
• Restricted Stock Units (RSUs): Shares granted outright upon vesting. No exercise price, but taxed as income when they vest.
• Restricted Stock: Actual shares purchased (often at a discount) that are subject to vesting. May allow an 83(b) election for tax planning.

Vesting Schedule

Most startup equity uses a 4-year vesting schedule with a 1-year cliff:

• Cliff: You receive nothing if you leave before the first year
• After the cliff: 25% vests at the 1-year mark, then the remainder vests monthly or quarterly over the next 3 years
• Acceleration: Some agreements include acceleration provisions that speed up vesting on certain events (like acquisition)

Key Terms to Review

• Exercise price (strike price): The price you pay to convert options into shares. Lower is better.
• Post-termination exercise window: How long you have to exercise options after leaving. Standard is 90 days, but some companies offer longer windows.
• Dilution: Your ownership percentage decreases as the company raises new funding rounds. Understand the current cap table and anticipated dilution.
• Liquidation preferences: Investors may get paid before common shareholders (you) in a sale or liquidation.
• Right of first refusal: The company may have the right to buy back your shares before you sell them.

Red Flags

• 90-day exercise window with a high exercise price (you may need to spend significant money within 3 months of leaving)
• No acceleration on change of control
• Repurchase rights that let the company buy back vested shares at cost
• Lack of transparency about the cap table and total shares outstanding

When to Consult a Lawyer

Consider consulting a startup-savvy attorney or tax advisor before accepting equity, especially regarding 83(b) elections (which have a strict 30-day deadline), exercise strategies, and tax implications.

This article is for informational purposes only and does not constitute legal advice. Consult a licensed attorney for guidance specific to your situation.