The Open Guide to Equity Compensation
❇️ This guide is now published on Holloway.
Read it there for search, booksmarks/highlights, expert commentary, and PDF/EPUB download.
Introduction
Equity compensation is the practice of granting partial ownership in a company in
exchange for work.
In its ideal form, equity compensation aligns the interests of individual employees with
the goals of the company they work for, which can yield dramatic results in team building,
innovation, and longevity of employment.
Each of these contributes to the creation of value—for a
company, for its users and customers, and for the individuals who work to make it a
success.
The ways equity can be granted as compensation—including restricted
stock, stock options, and restricted stock units—are notoriously complex. Equity
compensation involves confounding terminology, legal obscurities, and many high-stakes
decisions for those who give and receive it.
If you talk to enough employees and hiring managers, you’ll hear stories of how they or
their colleagues met with the painful consequences of not learning enough up front.
Though many people learn the basic ideas from personal experience or from colleagues or
helpful friends who have been through it before, the intricacies of equity compensation
are best understood by tax attorneys, corporate lawyers, and other professionals.
Decisions related to negotiating an offer and
exercising stock options, in particular, can have major financial
consequences. Because the value of employee equity is determined by the fate of the
company, an employee’s equity may be illiquid for a long time
or ultimately worth nothing, while taxes and the costs of exercise, if
they apply, may not be recouped.
Even when a company is doing well, an employee may suffer
catastrophic tax pitfalls because they didn’t anticipate the tax consequences
of their decisions.
Understanding the technicalities of equity compensation does not guarantee that fortune
will smile upon you as warmly as it did the early hires of
Facebook. But a thorough overview can help you be informed when
discussing with professionals for further assistance, make
better decisions for your personal situation, and avoid some common and
costly mistakes.
Why This Guide?
The first edition of this work, written by the same lead authors as the one you’re reading
now, received significant feedback and discussion
on Hacker News,
on GitHub, and from individual experts.
Now, Holloway is pleased to publish this new edition of the Guide.
We’ve expanded sections, added resources and visuals, and filled in gaps.
There is a lot of information about equity compensation spread across
blogs and articles that focus on specific components of the topic, such as vesting, types
of stock options, or equity levels.
We believe there is a need for a consolidated and shared resource, written by and for
people on different sides of compensation decisions, including employees, hiring managers,
founders, and students.
Anyone can feel overwhelmed by the complex details and high-stakes personal choices that
this topic involves.
This reference exists to answer the needs of beginners and the more experienced.
Holloway and our contributors are motivated by a single purpose:
To help readers understand important details and their contexts well enough to make better
decisions themselves.
The Guide aims to be practical (with concrete suggestions and pitfalls to avoid),
thoughtful (with context and multiple expert perspectives, including divergent opinion on
controversial topics), and concise (it is dense but contains only notable details—still,
it’s at least a three-hour read, with links to three hundred sources!).
The Guide does not purport to be either perfect or complete.
A reference like this is always in process.
That’s why we’re currently testing features to enable the Holloway community to suggest
improvements, contribute new sections, and call out anything that needs revision.
We welcome (and will gladly credit) your help.
We especially wish to recognize the dozens of people who have helped write,
review, edit, and improve it so far—and in the future—and hope you’ll check back often as
it improves.
Scope
This Guide currently covers:
- Equity compensation in C corporations in the United States.
- Equity compensation for most employees, advisors, and independent contractors in private
companies, from startups through larger private corporations.
- Limited coverage of equity compensation in public companies.
Topics not yet covered:
- Equity compensation programs, such as ESPPs
in public companies.
(We’d like to see this improve in the future.)
- Full details on executive equity compensation.
- Compensation outside the United States.
- Compensation in companies other than C corporations, including
LLCs and
S corporations, where equity compensation is
approached and practiced in very different ways.
For these situations, see other resources and get
professional advice.
Who May Find This Useful
Our aim is to be as helpful to the beginner as to those with more experience.
Having talked with employees, CEOs, investors, and lawyers, we can assure you that no
matter how much you know about equity compensation, you will likely run into confusion at
some point.
If you’re an employee or a candidate for a job, some of these may apply to you:
- You’ve heard phrases like stock, stock options, strike price, ISOs, RSUs, 83(b)
election, 409A valuation, AMT, or early exercise and know they are probably
important but are mystified by what some of them really mean or whether they apply to your
situation.
- You’re considering a job offer but don’t know how to
navigate or negotiate the equity component of the offer.
- You’re joining a startup for the first time and are overwhelmed by all the
paperwork.
- You’re quitting, taking a leave of absence, or are being laid off or fired from a company
where you have stock or options and are thinking through the decisions and consequences.
- A company you work for is going through an acquisition, IPO, or shutdown.
- You have stock in a private company and need cash.
Founders or hiring managers who need to talk about equity compensation with employees
or potential hires will also find this Guide useful.
As many entrepreneurs and hiring managers will tell you, this topic isn’t easy on that
side of the table, either!
Negotiating with candidates and fielding questions from candidates and employees requires
understanding the same complex technicalities of equity compensation well.
That said, this topic is not simple and we ask that readers be willing to invest time to
get through a lot of confusing detail.
If you’re in a hurry, or you don’t care to learn the details, this Guide may not be for
you. Seek advice.
A Note on Fairness
Much of what you read about equity compensation was written by a single person, from a
single vantage point.
The authors and editors of this Guide have navigated the territory of equity compensation
from the perspective of employees, hiring managers, founders, and lawyers.
We do believe that the knowledge here,
combined with professional advice, can make a significant
difference for both employees and hiring managers.
One of the difficulties for candidates negotiating equity compensation is that they may
have less information about what they are worth than the person hiring them.
Companies talk to many candidates and often have access to or pay for expensive
market-rate compensation data.
While some data on typical equity levels have been
published online, much of it fails to represent the value of a candidate with their own
specific experience in a specific role.
However, even without exact data, candidates and hiring managers can develop better mental
frameworks to think about offers and negotiations.
On the other hand, challenges are not limited to those of employees.
Founders and hiring managers also often struggle with talking through the web of
technicalities with potential hires, and can make equally poor decisions when making
offers. Either over-compensating or under-compensating employees can have unfortunate
consequences.
In short, both companies and employees are routinely hurt by uninformed decisions and
costly mistakes when it comes to equity compensation.
A shared resource is helpful for both sides.
Roadmap
The Holloway Reader
The Holloway Reader you’re using now is designed to help you find and navigate the
material you need. Use the search box.
It will reveal definitions, section-by-section results, and content contained in the
hundreds of resources we’ve linked to throughout the Guide.
Think of it as a mini library of the best content on equity compensation.
We also provide mouseover (or short tap on mobile) for definitions of terms, related
section suggestions, and external links while you read.
How This Guide Is Organized
This Guide contains a lot of material.
And it’s dense.
Some readers may wish to read front to back, but you can also search or navigate directly
to parts that are of interest to you, referring back to foundational topics as needed.
Equity compensation lies at the intersection of corporate law, taxation, and employee
compensation, and so requires some basic understanding of all three.
You might think compensation and taxation are separate topics, but they are so intertwined
it would be misleading to explain one without the other.
We cover material in logical order, so that if you do read the earlier sections first,
later sections on the interactions of tax and compensation will be clearer.
We start with Equity Compensation Basics: What compensation
and equity are, and why equity is used as compensation.
But before we get much further, we need to talk about what stock is, and how companies are
formed. Fundamentals of Stock Corporations covers how
companies organize their ownership, how stock is issued, public companies and private
companies, and IPOs and liquidity (which determine when equity is worth cash).
While not everyone reading this works at an early stage company, those who do can benefit
from understanding the role of equity in Startups and Growth. This is
good context for anyone involved in a private company that has taken on venture capital.
How Equity is Granted is the core of this Guide.
We describe the forms in which equity is most commonly granted, including restricted stock
grants, stock options, and RSUs.
Now is where it gets messier—taxes:
- Tax Basics: A technical summary of how taxation works.
Many of the headaches of equity compensation involve how it is taxed, including ordinary
income tax, long-term capital gains tax, and the lesser-known but sometimes critical
alternative minimum tax.
- Taxes on Equity Compensation: How much tax you owe is greatly
affected by the kind of equity you have (such as restricted stock awards, stock options,
or RSUs), when you choose to pay (including 83(b) elections), and when you choose to
exercise options.
After these technical concerns, we move on to how you can think about all this in
practice. These sections focus on scenarios common to employees and candidates, but are
also of likely interest to founders and hiring managers:
- Plans and Scenarios: Whether you have equity now or will in the
future, it is helpful to learn how to think about the value of equity and its tax
burden. We also cover whether you can sell private stock.
- Offers and Negotiations: Equity often comes up as you’re
negotiating or debating whether to accept a job offer.
Here we cover what to expect, what to ask, tips and pitfalls, and more.
Finally, we offer some additional resources:
- Documents and Agreements: A bit more detail on the actual legal
paperwork you’re likely to see as you negotiate and after you’ve accepted an offer.
- Further Reading: A curated list of what else you can read on the subject,
including many papers, books, and articles that have informed this Guide.
🚧 What about a Getting Help section outlining when to go to whom for professional help?
When to Turn Elsewhere
CEOs, CFOs, COOs, or anyone who runs a company or team of significant size should be
sure to talk to an equity compensation consultant or a specialist at a law firm to learn
about equity compensation plans.
Founders looking for an introduction to the legalities of running a company may wish to
check out Legal Concepts for Founders, from Clerky, in
addition to talking to a lawyer.
Founders should also lean on their investors for advice, as they may have additional
experience.
Executive compensation at large or public companies is an even more nuanced topic, on
both sides of the table.
Hire an experienced lawyer or compensation consultant.
There are extensive legal resources available
on executive compensation.
Seeking Professional Advice
This Guide does not replace professional advice.
Please read the full disclaimer and seek professional advice from a lawyer,
tax professional, or other compensation expert before making significant decisions.
Does that make reading through these details a waste of time?
Not at all. Important decisions rarely should or can be blindly delegated.
This Guide complements but does not replace the advice you get from professionals.
Working with the support of a professional can help you make better decisions when you
have an understanding of the topic yourself and know what questions to ask.
Equity Compensation Basics
History and Significance
Companies ranging from two-person startups to the
Fortune 500 have found that granting partial ownership in a
company is among the best methods to attract and retain exceptional talent.
In the United States, partial ownership through stock options has been a
key part of pay for executives and other employees since the 1950s.[^corpgovlaw.6vw7qt]
As recently as 2014, 7.2% of all private sector employees (8.5 million people) and
13.1% of all employees of companies with stock held stock options, according to the
National Center for Employee Ownership.[^nceoorgass.x6588n]
Many believe employee ownership has
💰fostered innovations
in technology, especially in Silicon Valley, from the
early days
of Hewlett-Packard to recent examples like Facebook.
Stock options helped the first 3,000 employees of Facebook enjoy roughly $23 billion at
the time the company went public.[^ftcomconte.x613np]
🌪 Some controversy surrounds the use of equity compensation for high-paid executives.
Public companies offer executives equity compensation in no small part because of a tax
loophole. In 1993, President Bill Clinton attempted to limit executive pay with a new
section[^treasurygo.tbpcyx] of the Internal Revenue Code.
Unfortunately, the legislation backfired;
a loophole made performance-based pay—including stock options—fully tax deductible,
thereby creating a dramatic incentive to pay executives through stock options.[^epiorgpubl.cq5o0o]
From 1970–79, the average compensation for a CEO of one of the 50 largest firms in the
United States was $1.2M, of which 11.2% was from stock options.
By 2000–05, the same numbers had risen to $9.2M and 37%, respectively.[^nberorgpap.wtsymr]
Growth and Risk
Generally, equity compensation is closely linked to the growth of a company.
Cash-poor startups persuade early employees to take pay cuts and join their team by
offering meaningful ownerships stakes, catering to hopes
that the company will one day grow large enough to go public or
be sold for an ample sum.
More mature but still fast-growing companies find offering compensation linked to
ownership is more attractive than high cash compensation to many candidates.
With the hope for growth, however, also comes risk. Large, fast-growing companies often
hit hard times.
And startups routinely fail or yield no returns for investors or
workers. According to a report
by Cambridge Associates and Fortune Magazine, between 1990 and 2010, about 60% of
venture capital-backed companies returned less than the original investment, leaving
employees with the painful realization that their startup was not, in fact, the next
Google. Of the remaining 40%, just a select few go on to make a many of their employees
wealthy, as has been the case with iconic high-growth companies, like Starbucks,[^investoped.aaps6n] UPS,[^moneycnnco.80o8bh]
Amazon,[^techcrunch.9ucopn] Google,[^dealbookny.es6h1j] or Facebook.[^enwikipedi.q7bc95]
Compensation and Equity
🄳 Compensation is any remuneration to a person (including employees, contractors,
advisors, founders, and board members) for services performed or rendered to a company.
Compensation comes in the forms of cash pay (salary and any bonuses) and any non-cash pay,
including benefits like
health insurance, family-related protections, perks, and retirement plans.
Company strategies for compensation are
far from simple.
Beth Scheer, head of talent at the venture fund Homebrew, offers a
thoughtful overview of compensation in startups.
Another term you may encounter is
total rewards, which refers to a model of
attracting and retaining employees using a combination of salary and incentive
compensation (like equity), benefits, recognition for contribution or commitment (like
awards and bonuses), training programs, and initiatives to improve the work environment.
🄳 In the context of compensation and investment, equity broadly refers to any kind of
ownership in a company that can be held by individuals (like employees or board members)
and by other businesses (like venture capital firms).
One common kind of equity is stock, but equity can take other forms, such as stock options
or warrants, that give ownership rights.
Commonly, equity also comes with certain conditions, such as vesting
This is 'The Open Guide to Equity Compensation,' a long-form reference guide covering stock options, RSUs, and the taxes around them for employees negotiating equity at startups and private companies, originally built as a GitHub project and now published on Holloway.