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it there for search, booksmarks/highlights, expert commentary, and PDF/EPUB download.*\n\n## Introduction\n\n**Equity compensation** is the practice of granting partial ownership in a company in\nexchange for work.\nIn its ideal form, equity compensation aligns the interests of individual employees with\nthe goals of the company they work for, which can yield dramatic results in team building,\ninnovation, and longevity of employment.\nEach of these [contributes](#history-and-significance) to the creation of value—for a\ncompany, for its users and customers, and for the individuals who work to make it a\nsuccess.\n\nThe [ways equity can be granted](#how-equity-is-granted) as compensation—including restricted\nstock, stock options, and restricted stock units—are **notoriously complex**. Equity\ncompensation involves confounding terminology, legal obscurities, and many high-stakes\ndecisions for those who give and receive it.\n\nIf you talk to enough employees and hiring managers, you’ll hear stories of how they or\ntheir colleagues met with the painful consequences of not learning enough up front.\nThough many people learn the basic ideas from personal experience or from colleagues or\nhelpful friends who have been through it before, the intricacies of equity compensation\nare best understood by tax attorneys, corporate lawyers, and other professionals.\n\nDecisions related to [negotiating an offer](#offers-and-negotiations) and\n[exercising stock options](#stock-option-scenarios), in particular, can have **major financial\nconsequences**. Because the value of employee equity is determined by the fate of the\ncompany, an employee’s equity may be [illiquid](#what-is-private-stock-worth) for a long time\nor ultimately [worth nothing](#growth-and-risk), while taxes and the costs of exercise, if\nthey apply, may not be recouped.\nEven when a company is doing well, an employee may suffer\n[catastrophic tax pitfalls](#tax-dangers) because they didn’t anticipate the tax consequences\nof their decisions.\n\nUnderstanding the technicalities of equity compensation does not guarantee that fortune\nwill smile upon you as warmly as it did [the early hires](#history-and-significance) of\nFacebook. But a thorough overview can help you be informed when\n[discussing with professionals](#seeking-professional-advice) for further assistance, make\nbetter decisions for your personal situation, and avoid some [common](#tax-dangers) and\n[costly](#the-amt-trap) mistakes.\n\n### Why This Guide?\n\nThe first edition of this work, written by the same lead authors as the one you’re reading\nnow, received significant feedback and discussion\n[on Hacker News](https://news.ycombinator.com/item?id=10880726),\n[on GitHub](https://github.com/jlevy/og-equity-compensation), and from individual experts.\nNow, Holloway is pleased to publish this new edition of the Guide.\nWe’ve expanded sections, added resources and visuals, and filled in gaps.\n\nThere is [a lot of information](#further-reading) about equity compensation spread across\nblogs and articles that focus on specific components of the topic, such as vesting, types\nof stock options, or equity levels.\nWe believe there is a need for a consolidated and shared resource, written by and for\npeople on different sides of compensation decisions, including employees, hiring managers,\nfounders, and students.\nAnyone can feel overwhelmed by the complex details and high-stakes personal choices that\nthis topic involves.\nThis reference exists to answer the needs of beginners and the more experienced.\n\nHolloway and our contributors are motivated by a single purpose:\nTo help readers understand important details and their contexts well enough to make better\ndecisions themselves.\nThe Guide aims to be **practical** (with concrete suggestions and pitfalls to avoid),\n**thoughtful** (with context and multiple expert perspectives, including divergent opinion on\ncontroversial topics), and **concise** (it is dense but contains only notable details—still,\nit’s at least a three-hour read, with links to three hundred sources!).\n\nThe Guide does not purport to be either perfect or complete.\nA reference like this is always in process.\nThat’s why we’re currently testing features to enable the Holloway community to suggest\nimprovements, contribute new sections, and call out anything that needs revision.\nWe welcome (and will gladly credit) [your help](#please-help).\n\nWe especially wish to [recognize](#credits) the dozens of people who have helped write,\nreview, edit, and improve it so far—and in the future—and hope you’ll check back often as\nit improves.\n\n### Scope\n\nThis Guide **currently covers**:\n\n- Equity compensation in **C corporations** in the **United States**.\n- Equity compensation for most employees, advisors, and independent contractors in private\n  companies, from startups through larger private corporations.\n- Limited coverage of equity compensation in public companies.\n\nTopics **not yet covered**:\n\n- Equity compensation programs, such as [ESPPs](https://www.investopedia.com/terms/e/espp.asp)\n  in public companies.\n  (We’d like to [see this improve](#please-help) in the future.)\n- Full details on executive equity compensation.\n- Compensation outside the United States.\n- Compensation in companies other than C corporations, including\n  [LLCs](https://en.wikipedia.org/wiki/Limited_liability_company) and\n  [S corporations](https://en.wikipedia.org/wiki/S_corporation), where equity compensation is\n  approached and practiced in very different ways.\n\nFor these situations, see [other resources](#when-to-turn-elsewhere) and get\n[professional advice](#seeking-professional-advice).\n\n### Who May Find This Useful\n\nOur aim is to be as helpful to the beginner as to those with more experience.\nHaving talked with employees, CEOs, investors, and lawyers, we can assure you that no\nmatter how much you know about equity compensation, you will likely run into confusion at\nsome point.\n\nIf you’re an **employee** or a **candidate for a job**, some of these may apply to you:\n\n- You’ve heard phrases like *stock*, *stock options*, *strike price*, *ISOs*, *RSUs*, *83(b)\n  election*, *409A valuation*, *AMT*, or *early exercise* and know they are probably\n  important but are mystified by what some of them really mean or whether they apply to your\n  situation.\n- You’re considering a job offer but don’t know how to\n  [navigate or negotiate](#offers-and-negotiations) the equity component of the offer.\n- You’re joining a startup for the first time and are overwhelmed by all the\n  [paperwork](#documents-and-agreements).\n- You’re quitting, taking a leave of absence, or are being laid off or fired from a company\n  where you have stock or options and are thinking through the decisions and consequences.\n- A company you work for is going through an acquisition, IPO, or shutdown.\n- You have stock in a private company and [need cash](#stock-option-scenarios).\n\n**Founders** or **hiring managers** who need to talk about equity compensation with employees\nor potential hires will also find this Guide useful.\nAs many entrepreneurs and hiring managers will tell you, this topic isn’t easy on that\nside of the table, either!\nNegotiating with candidates and fielding questions from candidates and employees requires\nunderstanding the same complex technicalities of equity compensation well.\n\nThat said, this topic is **not simple** and we ask that readers be willing to invest time to\nget through a lot of confusing detail.\nIf you’re in a hurry, or you don’t care to learn the details, this Guide may not be for\nyou. [Seek advice](#seeking-professional-advice).\n\n### A Note on Fairness\n\nMuch of what you read about equity compensation was written by a single person, from a\nsingle vantage point.\nThe authors and editors of this Guide have navigated the territory of equity compensation\nfrom the perspective of employees, hiring managers, founders, and lawyers.\nWe do believe that the knowledge here,\n[combined with professional advice](#seeking-professional-advice), can make a significant\ndifference for **both employees and hiring managers**.\n\nOne of the difficulties for candidates negotiating equity compensation is that they may\nhave less information about what they are worth than the person hiring them.\nCompanies talk to many candidates and often have access to or pay for expensive\nmarket-rate compensation data.\nWhile some data on [typical equity levels](#typical-employee-equity-levels) have been\npublished online, much of it fails to represent the value of a candidate with their own\nspecific experience in a specific role.\nHowever, even without exact data, candidates and hiring managers can develop better mental\nframeworks to think about [offers and negotiations](#offers-and-negotiations).\n\nOn the other hand, challenges are not limited to those of employees.\nFounders and hiring managers also often struggle with talking through the web of\ntechnicalities with potential hires, and can make equally poor decisions when making\noffers. Either over-compensating or under-compensating employees can have unfortunate\nconsequences.\n\nIn short, both companies and employees are routinely hurt by uninformed decisions and\ncostly mistakes when it comes to equity compensation.\nA shared resource is helpful for both sides.\n\n## Roadmap\n\n### The Holloway Reader\n\nThe Holloway Reader you’re using now is designed to help you find and navigate the\nmaterial you need. **Use the search box.**\nIt will reveal definitions, section-by-section results, and content contained in **the\nhundreds of resources we’ve linked to** throughout the Guide.\nThink of it as a mini library of the best content on equity compensation.\nWe also provide mouseover (or short tap on mobile) for **definitions of terms**, related\nsection suggestions, and external links while you read.\n\n### How This Guide Is Organized\n\nThis Guide contains a lot of material.\nAnd it’s dense.\nSome readers may wish to read front to back, but you can also **search or navigate directly**\nto parts that are of interest to you, **referring back** to foundational topics as needed.\n\nEquity compensation lies at the intersection of corporate law, taxation, and employee\ncompensation, and so requires some basic understanding of all three.\nYou might think compensation and taxation are separate topics, but they are so intertwined\nit would be misleading to explain one without the other.\nWe cover material in logical order, so that if you do read the earlier sections first,\nlater sections on the interactions of tax and compensation will be clearer.\n\nWe start with [**Equity Compensation Basics**](#equity-compensation-basics): What compensation\nand equity are, and why equity is used as compensation.\n\nBut before we get much further, we need to talk about what stock is, and how companies are\nformed. [**Fundamentals of Stock Corporations**](#fundamentals-of-stock-corporations) covers how\ncompanies organize their ownership, how stock is issued, public companies and private\ncompanies, and IPOs and liquidity (which determine when equity is worth cash).\n\nWhile not everyone reading this works at an early stage company, those who do can benefit\nfrom understanding the role of equity in [**Startups and Growth**](#startups-and-growth). This is\ngood context for anyone involved in a private company that has taken on venture capital.\n\n[**How Equity is Granted**](#how-equity-is-granted) is the core of this Guide.\nWe describe the forms in which equity is most commonly granted, including restricted stock\ngrants, stock options, and RSUs.\n\nNow is where it gets messier—taxes:\n\n- [**Tax Basics**](#tax-basics): A technical summary of how taxation works.\n  Many of the headaches of equity compensation involve how it is taxed, including ordinary\n  income tax, long-term capital gains tax, and the lesser-known but sometimes critical\n  alternative minimum tax.\n- [**Taxes on Equity Compensation**](#taxes-on-equity-compensation): How much tax you owe is greatly\n  affected by the kind of equity you have (such as restricted stock awards, stock options,\n  or RSUs), when you choose to pay (including 83(b) elections), and when you choose to\n  exercise options.\n\nAfter these technical concerns, we move on to how you can think about all this in\npractice. These sections focus on scenarios common to employees and candidates, but are\nalso of likely interest to founders and hiring managers:\n\n- [**Plans and Scenarios**](#plans-and-scenarios): Whether you have equity now or will in the\n  future, it is helpful to learn *how to think about* the value of equity and its tax\n  burden. We also cover whether you can [sell private stock](#can-you-sell-private-stock).\n- [**Offers and Negotiations**](#offers-and-negotiations): Equity often comes up as you’re\n  negotiating or debating whether to accept a job offer.\n  Here we cover what to expect, what to ask, tips and pitfalls, and more.\n\nFinally, we offer some additional resources:\n\n- [**Documents and Agreements**](#documents-and-agreements): A bit more detail on the actual legal\n  paperwork you’re likely to see as you negotiate and after you’ve accepted an offer.\n- [**Further Reading**](#further-reading): A curated list of what else you can read on the subject,\n  including many papers, books, and articles that have informed this Guide.\n\n🚧 What about a Getting Help section outlining when to go to whom for professional help?\n\n### When to Turn Elsewhere\n\n**CEOs**, **CFOs**, **COOs**, or anyone who runs a company or team of significant size should be\nsure to talk to an equity compensation consultant or a specialist at a law firm to learn\nabout equity compensation plans.\n\n**Founders** looking for an introduction to the legalities of running a company may wish to\ncheck out [*Legal Concepts for Founders*](https://handbook.clerky.com/), from Clerky, in\naddition to talking to a lawyer.\nFounders should also lean on their investors for advice, as they may have additional\nexperience.\n\n**Executive compensation** at large or public companies is an even more nuanced topic, on\nboth sides of the table.\nHire an experienced lawyer or compensation consultant.\nThere are extensive legal [resources](https://www.compensationstandards.com/home/) available\non executive compensation.\n\n### Seeking Professional Advice\n\nThis Guide does not replace professional advice.\n\nPlease read the full [disclaimer](#disclaimer) and seek professional advice from a lawyer,\ntax professional, or other compensation expert before making significant decisions.\n\nDoes that make reading through these details a waste of time?\nNot at all. Important decisions rarely should or can be blindly delegated.\nThis Guide *complements but does not replace* the advice you get from professionals.\nWorking with the support of a professional can help you make better decisions when you\nhave an understanding of the topic yourself and know what questions to ask.\n\n## Equity Compensation Basics\n\n### History and Significance\n\nCompanies ranging from two-person startups to the\n[Fortune 500](http://fortune.com/fortune500/) have found that granting partial ownership in a\ncompany is among the best methods to attract and retain exceptional talent.\nIn the United States, partial ownership through [stock options](#stock-options) has been a\nkey part of pay for executives and other employees since the 1950s.[^corpgovlaw.6vw7qt]\nAs recently as 2014, **7.2%** of all private sector employees (**8.5 million** people) and\n**13.1%** of *all* employees of companies with stock held stock options, according to the\nNational Center for Employee Ownership.[^nceoorgass.x6588n]\nMany believe employee ownership has\n[💰fostered innovations](https://www.wsj.com/articles/reviving-the-flagging-spirit-of-silicon-valley-1428706671)\nin technology, especially in Silicon Valley, from the\n[early days](http://www.hp.com/hpinfo/abouthp/histnfacts/publications/measure/pdf/1976_07.pdf)\nof Hewlett-Packard to recent examples like Facebook.\nStock options helped the first 3,000 employees of Facebook enjoy roughly **$23 billion** at\nthe time the company went public.[^ftcomconte.x613np]\n\n🌪 Some controversy surrounds the use of equity compensation for high-paid executives.\nPublic companies offer executives equity compensation in no small part because of a tax\nloophole. In 1993, President Bill Clinton attempted to limit executive pay with a new\nsection[^treasurygo.tbpcyx] of the Internal Revenue Code.\nUnfortunately, the legislation backfired;\na loophole made performance-based pay—including stock options—fully tax deductible,\nthereby creating a dramatic incentive to pay executives through stock options.[^epiorgpubl.cq5o0o]\nFrom 1970–79, the average compensation for a CEO of one of the 50 largest firms in the\nUnited States was **$1.2M**, of which **11.2%** was from stock options.\nBy 2000–05, the same numbers had risen to **$9.2M** and **37%**, respectively.[^nberorgpap.wtsymr]\n\n### Growth and Risk\n\nGenerally, equity compensation is closely linked to the **growth** of a company.\nCash-poor startups persuade early employees to take pay cuts and join their team by\noffering meaningful [ownerships stakes](#typical-employee-equity-levels), catering to hopes\nthat the company will one day grow large enough to [go public](#ipos) or\n[be sold](#sales-and-liquidity) for an ample sum.\nMore mature but still fast-growing companies find offering compensation linked to\nownership is more attractive than high cash compensation to many candidates.\n\nWith the hope for growth, however, also comes **risk**. Large, fast-growing companies often\nhit hard times.\nAnd [startups](#startups-and-growth) routinely fail or yield no returns for investors or\nworkers. According to [a report](http://fortune.com/2017/06/27/startup-advice-data-failure/)\nby Cambridge Associates and Fortune Magazine, between 1990 and 2010, **about 60%** of\nventure capital-backed companies returned less than the original investment, leaving\nemployees with the painful realization that their startup was not, in fact, the next\nGoogle. Of the remaining **40%**, just a select few go on to make a many of their employees\nwealthy, as has been the case with iconic high-growth companies, like Starbucks,[^investoped.aaps6n] UPS,[^moneycnnco.80o8bh]\nAmazon,[^techcrunch.9ucopn] Google,[^dealbookny.es6h1j] or Facebook.[^enwikipedi.q7bc95]\n\n### Compensation and Equity\n\n🄳 **Compensation** is any remuneration to a person (including employees, contractors,\nadvisors, founders, and board members) for services performed or rendered to a company.\nCompensation comes in the forms of cash pay (salary and any bonuses) and any non-cash pay,\nincluding [benefits](https://en.wikipedia.org/wiki/Employee_benefits#United_States) like\nhealth insurance, family-related protections, perks, and retirement plans.\n\nCompany strategies for compensation are\n[far from simple](http://firstround.com/review/counterintuitive-comp-tips-for-the-unwary-and-uninitiated/).\nBeth Scheer, head of talent at the venture fund Homebrew, offers a\n[thoughtful overview](https://quip.com/HEB3Ah9dYD6o) of compensation in startups.\n\nAnother term you may encounter is\n[*total rewards*](https://www.worldatwork.org/total-rewards-model/), which refers to a model of\nattracting and retaining employees using a combination of salary and incentive\ncompensation (like equity), benefits, recognition for contribution or commitment (like\nawards and bonuses), training programs, and initiatives to improve the work environment.\n\n🄳 In the context of compensation and investment, **equity** broadly refers to any kind of\nownership in a company that can be held by individuals (like employees or board members)\nand by other businesses (like venture capital firms).\nOne common kind of equity is stock, but equity can take other forms, such as stock options\nor warrants, that give ownership rights.\nCommonly, equity also comes with certain conditions, such as vesting or repurchase rights.\nNote the term *equity* also has\n[several other](https://www.investopedia.com/terms/e/equity.asp) technical meanings in\naccounting and real estate.\n\n🄳 [**Equity compensation**](http://www.investopedia.com/terms/e/equity-compensation.asp) is the\npractice of granting equity in exchange for work.\n\nIn this Guide we focus on equity compensation in stock corporations, the kind of company\nwhere ownership is represented by stock.\n(We describe stock in more detail in [the next section](#fundamentals-of-stock-corporations).)\nEquity compensation in the form of a direct grant of stock with no strings attached is\nvery rare. Instead, employees are given stock with additional restrictions placed on it,\nor are given contractual rights that later can lead to owning stock.\nThese forms of equity compensation include restricted stock, stock options, and restricted\nstock units, each of which we’ll [describe in detail](#how-equity-is-granted).\n\n### The Goals of Equity Compensation\n\nThe purpose of equity compensation is threefold:\n\n- **Attract and retain talent.**\n  When a company already has or can be predicted to have significant financial success,\n  talented people are [incentivized](https://avc.com/2010/10/employee-equity-options/) to work\n  for the company by the prospect of their equity being\n  [worth a lot](https://www.entrepreneur.com/article/253438) of money in the future.\n  The actual probability of life-changing lucre may be low (or at least, lower than you may\n  think if your entire knowledge of startups is watching “[The Social Network](https://en.wikipedia.org/wiki/The_Social_Network)”).\n  But even a small chance at winning big can be worth the risk to many people, and to some\n  the risk itself can be exciting.\n- **Align incentives.**\n  Even companies that can afford to pay lots of cash may prefer to give employees equity,\n  so that employees work to increase the *future* value of the company.\n  In this way, equity aligns individuals’ incentives with the interests of the company.\n  At its best, this philosophy fosters an environment of teamwork and a “rising tides lift\n  all boats” mentality.\n  It also encourages everyone involved to think\n  [long-term](https://www.cebglobal.com/blogs/equity-compensation-will-stop-short-termism-and-boost-growth/),\n  which is key for company success.\n  As we’ll [discuss later](#offers-and-negotiations), the amount of equity you’re offered\n  usually reflects both your contribution to the company and your commitment to the company\n  in the future.\n- **Reduce cash spending.**\n  By giving equity, a company can often pay less in cash compensation to employees now,\n  with the hope of rewarding them later, and put that money toward other investments or\n  operating expenses.\n  This can be essential in the early stages of a company or at other times where there may\n  not be enough revenue to pay large salaries.\n  Equity compensation can also help recruit senior employees or executives who would\n  otherwise command especially high salaries.\n\n🚧 Mention or link to lockup periods etc.\n\n## Fundamentals of Stock Corporations\n\nIn this section, we describe the basics of how stock and shares are used.\n\nThose familiar with stock, stock corporations, public companies, and private companies can\n[jump ahead](#how-equity-is-granted) to how those companies grant equity.\n\n### Kinds of Companies\n\n🄳 A **company** is a legal entity formed under corporate law for the purpose of conducting\ntrade. In the United States, specific rules and regulations govern several kinds of\n[business entities](https://en.wikipedia.org/wiki/Types_of_business_entity#United_States).\nFederal and state law have significant implications on liability and taxation for each\nkind of company.\nNotable types of companies include sole proprietorships, partnerships, limited liability\ncompanies (LLCs), S corporations, and C corporations.\n\n🄳 A **corporation** is a company that is legally recognized as a single entity.\nThe corporation itself, and not its owners, is obligated to repay debts and accountable\nunder contracts and legal actions (that is, is a “[legal person](https://en.wikipedia.org/wiki/Legal_person)”).\nMost commonly, the term *corporation* is used to refer to a\n**[stock corporation (or joint-stock company)](https://en.wikipedia.org/wiki/Joint-stock_company)**,\nwhich is a corporation where ownership is managed using stock. **Non-stock corporations**\nthat do not issue stock exist as well, the most common being\n[nonprofit organizations](https://en.wikipedia.org/wiki/Nonprofit_organization). (A few\n[less common](https://en.wikipedia.org/wiki/Non-stock_corporation) for-profit non-stock\ncorporations also exist.)\n\nIn practice, people often use the word *company* to mean *corporation*.\n\n🄳 **Incorporation** is the\n[legal process](https://en.wikipedia.org/wiki/Incorporation_(business)) of forming (or\n**incorporating**) a new corporation, such as a business or nonprofit.\nCorporations can be created in any country.\nIn the United States, incorporation is handled by state law, and involves filing\n[articles of incorporation](https://en.wikipedia.org/wiki/Articles_of_incorporation) and a\nvariety of other [required information](https://handbook.clerky.com/formation/process) with\nthe Secretary of State.\n(Note that the formation of companies that are not corporations, such as partnerships or\nLLCs, is not the same as incorporation.)\n\n🄳 A [**C corporation (or C corp)**](https://en.wikipedia.org/wiki/C_corporation) is a type of\nstock corporation in the United States with certain federal\n[tax treatment](https://ct.wolterskluwer.com/resource-center/articles/what-c-corporation). It\nis the most prevalent kind of corporation.[^investoped.m9wdqp]\nMost large, well-known American companies are C corporations.\nC corporations differ from\n[S corporations](https://www.incorporate.com/starting-a-business/s-corporation) and other\nbusiness entities in several ways, including how income is taxed and who may own stock.\nC corporations have no limit on the number of shareholders allowed to own part of the\ncompany. They also allow other corporations, as well as partnerships, trusts, and other\nbusinesses, to own stock.\n\nC corps are overwhelmingly popular for early-stage\n[private companies](#public-and-private-companies) looking to sell part of their business in\nexchange for investment from individuals and organizations like venture capital firms\n(which are often partnerships), and for established public companies selling large numbers\nof stock to individuals and other companies on the\n[public exchange](https://en.wikipedia.org/wiki/Stock_exchange).\n\nIn practice, for a few reasons, these companies are usually formed in Delaware, so\nlegalities of all this are defined in Delaware law.[^quoracomwh.wsnr2b][^nytimescom.67ksyb]\nYou can think of Delaware law as the primary “language” of U.S. corporate law.\nIncorporating a company in Delaware has evolved into a national standard for high-growth\ncompanies, regardless of where they are physically located.\n\n🔸 This Guide focuses specifically on C corporations and [does not cover](#scope) how equity\ncompensation works in LLCs, S corporations, partnerships, or sole proprietorships.\nBoth equity and compensation are handled in significantly different ways in each of these\nkinds of businesses.\n\nLoosely, one way to think about companies is that they are simply a set of\n[contracts](https://www.law.cornell.edu/wex/contract), negotiated over time between the people\nwho own and operate the company, and which are enforced by the government, that aligns the\ninterests of everyone involved in creating things customers are willing to pay for.\nKey to these contracts is a way to precisely track ownership of the company;\nissuing stock is how companies often choose to do this.\n\n🚧 Mention how court cases are settled?\n\n### Stock and Shares\n\n🄳 [**Stock**](https://en.wikipedia.org/wiki/Stock) is a legal invention that represents\nownership in a company. [**Shares**](https://en.wikipedia.org/wiki/Share_(finance)) are portions\nof stock that allow a company to grant ownership to a variety of people or other companies\nin flexible ways.\nEach **shareholder (or stockholder)**, as these owners are called, holds a specific number\nof shares. Founders, investors, employees, board members, contractors, advisors, and other\ncompanies, like law firms, can all be shareholders.\n\n🄳 Stock ownership is often formalized on **stock certificates**, which are fancy pieces of\npaper that prove who owns the stock.\n\nSometimes you have stock but don’t have the physical certificate, as it may be held for\nyou at a law office.\n\nSome companies now manage their ownership through online services called *ownership\nmanagement platforms*, such as [Carta](https://carta.com/). If the company you work for uses\nan ownership management platform, you will be able to view your stock certificates and\nstock values online.\n\nYounger companies may also choose to keep their stock *uncertificated*, which means your\nsole evidence of ownership is your contracts with the company, and your spot on the\ncompany’s cap table, without having a separate certificate for it.\n\n🄳 [**Outstanding shares**](http://www.investopedia.com/terms/o/outstandingshares.asp) refer to\nthe total number of shares held by all shareholders.\nThis number starts at an essentially arbitrary value (such as 10 million) when the company\nis created, and thereafter will increase as new shares are added (issued) and granted to\npeople in exchange for money or services.\n\nOutstanding shares may increase or decrease for other reasons too, such as\n[stock splits and share buybacks](http://www.investorguide.com/article/11713/splits-and-buybacks-explained/),\nwhich we won’t get into here.\n\nLater, we discuss several [subtleties](#counting-shares) in how shares are counted.\n\n🚧 What is a good overview on stock splits and share buyback.\nKey resources?\n\n🄳 Any shareholder has a **percentage ownership** in the company, determined by dividing the\nnumber of shares they own by the number of outstanding shares.\nAlthough stock paperwork will always list numbers of shares, if share value is uncertain,\npercentage ownership is often a more meaningful number, particularly if you know or can\nestimate a likely valuation of the company.\nEven if the number of shares a person has is fixed, their percentage ownership will change\nover time as the outstanding shares change.\nTypically, this number is presented in percent or\n[**basis points**](https://www.investopedia.com/terms/b/basispoint.asp) (hundredths of a percent).\n\n### Public and Private Companies\n\n🄳 [**Public companies**](https://en.wikipedia.org/wiki/Public_company) are corporations in which\nany member of the public can own stock.\nPeople can buy and sell the stock for cash on public\n[stock exchanges](https://www.investopedia.com/terms/e/exchange.asp). The value of a company’s\nshares is the value displayed in the stock market reports, so shareholders know how much\ntheir stock is worth.\n\n🄳 Most smaller companies, including all startups, are\n[**private companies**](https://en.wikipedia.org/wiki/Privately_held_company) with owners who\ncontrol how those companies operate.\nUnlike a public company, where anyone is able to buy and sell stock, owners of a private\ncompany control who is able to buy and sell stock.\nThere may be few or no transactions, or they may not be publicly known.\n\n🚧 What are public exchanges and how is stock bought and sold in practice?\nMention accredited investors?\n\n### Governance\n\n🄳 A corporation has a **board of directors**, a\n[group of people](https://en.wikipedia.org/wiki/Board_of_directors) whose legal obligation is\nto oversee the company and ensure it serves the best interests of the shareholders.\nPublic companies are legally obligated to have a board of directors, while private\ncompanies often elect to have one.\nThe board typically consists of **inside directors**, such as the CEO, one or two founders,\nor executives employed by the company, and **outside directors**, who are not involved in\nthe day-to-day workings of the company.\nThese **board members** are elected individuals who have legal, corporate governance rights\nand duties when it comes to voting on key company decisions.\nA board member is said to have a **board seat** at the company.\n\nBoards of directors range from 3 to 31 members, with an average size of 9.[^investoped.fn52lq] Boards are\nalmost always an odd number in order to avoid tie votes.\nIt’s worth noting that the state of California requires public companies to have at least\none woman on their boards.[^nytimescom.gec7iw]\n\nKey decisions of the board are made formally in *board meetings* or in writing (called\n*written consent*).[^dlapiperac.wb4617] Many decisions around granting equity to employees are approved by the\nboard of directors.\n\n🚧 This section could be expanded, and also include more legal links.\n\n### IPOs\n\n🄳 A private company becomes a public company in a process called an\n[**initial public offering (IPO)**](https://en.wikipedia.org/wiki/Initial_public_offering).\nHistorically, only private companies with a strong track record of years of growth have\nconsidered themselves ready to take this significant step.\nThe IPO has [pros and cons](https://www.investopedia.com/university/ipo/ipo.asp) that include\nexchanging a host of high regulatory costs for the benefits of significant capital.\nAfter a company “IPOs” or “**goes public**,\" investors and the general public can buy stock,\nand existing shareholders can sell their stock far more easily than when the company was\nprivate.\n\nCompanies take years to IPO after being formed.\nThe median time between a company’s founding and its IPO has been increasing.\nAccording to a Harvard report, companies that went public in **2016** took **7.7 years** to do\nso, compared to **3.1 years** for companies that went public in **1996**.[^corpgovlaw.vbw82s]\n\n🚧 What are the restrictions and regulations on selling stock that affect employees at\nIPO? What is a lockup period?\n\n### Sales and Liquidity\n\n❗️ With private companies, it can be very [hard to know](#what-is-private-stock-worth) the\nvalue of equity.\nBecause the value of private company stock is not determined by regular trades on public\nmarkets, shareholders can only make educated guesses about the likely future value, at a\ntime when they will be able to sell stock.\n\nAfter all, private company stock is simply a legal agreement that entitles you to\nsomething of highly uncertain value, and could well be worthless in the future, or highly\nvaluable, depending on the fate of the company.\n\n☝️ We’ll discuss the notion of a company officially assigning a\n[fair market value](#409a-valuations) later, but even if a company gives you a value for your\nstock for tax and accounting purposes, it doesn’t mean you can expect to sell it for that\nvalue!\n\n🄳 An [**acquisition**](https://www.investopedia.com/terms/a/acquisition.asp) is the purchase of\nmore than 50% of the shares of one company (the acquired company) by another company (the\npurchaser). This is also called a **sale** of the acquired company.\nIn an acquisition, the acquired company cedes control to the purchaser.\n\n🄳 The ability to buy and sell stock is called **liquidity**. In startups and many private\ncompanies, it is often hard to sell stock until the company is sold or goes public, so\nthere is little or no liquidity for shareholders until those events occur.\nThus, sales and IPOs are called both **exits** and **liquidity events**. Sales, dissolutions,\nand bankruptcy are all called **liquidations**.\n\nOften people wish they could sell stock in a private company, because they would prefer\nhaving the cash.\nThis is only possible occasionally.\nWe get into the details [later](#can-you-sell-private-stock), in our section on selling\nprivate stock.\n\n🄳 A [**dividend**](http://www.investopedia.com/terms/d/dividend.asp) is a distribution of a\ncompany’s profit to shareholders, authorized by the board of directors.\nEstablished public companies and some private companies pay dividends, but this is rare\namong startups and companies focused on rapid growth, since they often wish to re-invest\ntheir profits into expanding the business, rather than paying that money back to\nshareholders. Amazon, for example, has\n[never paid](https://www.fool.com/investing/2017/12/28/will-amazon-start-paying-a-dividend-in-2018.aspx)\ndividends.\n\n## Startups and Growth\n\nIf you’re considering working for a startup, what we cover next on how these early-stage\ncompanies raise money and grow is helpful in understanding what your equity may be worth.\n\nIf you’re only concerned with large and established companies, you can skip ahead to\n[how equity is granted](#how-equity-is-granted).\n\n### Startups\n\n🄳 A [**startup**](https://en.wikipedia.org/wiki/Startup_company) is an emerging company,\ntypically a private company, that aspires to grow quickly in size, revenue, and influence.\nOnce a company is established in the market and successful for a while, it usually stops\nbeing called a startup.\n\n☝️ Unlike the terminology around corporations, which has legal significance, the term\n*startup* is informal, and not everyone uses it consistently.\n\nStartups are not the same as small businesses.\nSmall businesses, like a coffee shop or plumbing business, typically intend to grow slowly\nand organically, while relying much less on investment capital and equity compensation.\nDistinguished startup investor\n[Paul Graham](https://en.wikipedia.org/wiki/Paul_Graham_(programmer)) has\n[emphasized](http://www.paulgraham.com/growth.html) that it’s best to think of a startup as\nany [early stage](#stages-of-a-startup) company intending to grow quickly.\n\n∑ C corporations dominate the startup ecosystem.\nLLCs tend to be better suited for slower-growth companies that intend to distribute\nprofits instead of re-investing them for growth.\nBecause of this, and for complex reasons related to how their capital is raised, venture\ncapitalists significantly prefer to invest in C corporations.\n\n🚧 What are good stats on how many people work in startups vs.\nestablished companies?\n\n### Fundraising, Growth, and Dilution\n\nMany large and successful companies began as startups.\nIn general, startups rely on investors to help fund rapid growth.\n\n🄳 **Fundraising** is the process of seeking capital to build or scale a business.\nSelling shares in a business to investors is one form of fundraising, as are loans and\n[initial coin offerings](https://en.wikipedia.org/wiki/Initial_coin_offering). **Financing**\nrefers both to fundraising from outside sources and to bringing in revenue from selling a\nproduct or service.\n\n🄳 **Venture capital** is a form of financing for early-stage companies that individual\ninvestors or investment firms provide in exchange for partial ownership, or equity, in a\ncompany. These investors are called **venture capitalists (or VCs)**. Venture capitalists\ninvest in companies they perceive to be capable of growing quickly and commanding\nsignificant market share.\n“Venture” refers to the risky nature of investing in early-stage businesses—typically\nstartups—with unproven business models.\n\nA startup goes through several [stages of growth](#stages-of-a-startup) as it raises capital\nbased on the hope and expectation that the company will grow and make more money in the\nfuture.\n\n🄳 Companies add (or “issue”) shares during fundraising, which can be exchanged for cash\nfrom investors.\nAs the number of outstanding shares goes up, the percentage ownership of each shareholder\ngoes down. This is called [**dilution**](http://www.investopedia.com/terms/d/dilution.asp).\n\n☝️ Dilution doesn’t necessarily mean that you’re losing anything as a shareholder.\nAs a company issues stock and raises money, the smaller percentage of the company you *do*\nhave could be worth more.\nThe size of your slice gets relatively smaller, but, if the company is growing, the size\nof the cake gets bigger.\nFor example, a typical startup might have three rounds of funding, with each round of\nfunding issuing 20% more shares.\nAt the end of the three rounds, there are more outstanding shares—roughly 73% more in this\ncase, since 120%×120%×120% is 173%—and each shareholder owns proportionally less of the\ncompany.\n\n🄳 The [**valuation**](https://en.wikipedia.org/wiki/Valuation_(finance)) of the company is the\npresent value investors believe the company has.\nIf the company is doing well, growing revenue or showing indications of future revenue\n(like a growing number of users or traction in a promising market), the company’s\nvaluation will usually be on the rise.\nThat is, the [price](https://en.wikipedia.org/wiki/Share_price) for an investor to buy one\nshare of the company would be increasing.\n\n❗️ Of course, things do not always go well, and the valuation of a company does not always\ngo up. It can happen that a company fails entirely and all ownership stakes become\nworthless, or that the valuation is lower than expected and\n[certain kinds](#classes-of-stock) of shares become worthless while other kinds have some\nvalue. When investors and leadership in a company expect the company to do better than it\nactually does, it can have a lot of disappointing consequences for shareholders.\n\n### Dilution Illustrations\n\nThese visualizations illustrate how ownership of a venture-backed company evolves as\nfunding is raised.\nOne scenario imagines changes to ownership in a well-performing startup, and the other is\nloosely based on a careful analysis of Zipcar,[^reactionwh.uw835n] a ride-sharing company that experienced\nsubstantial dilution before eventually going public and being\n[acquired](#sales-and-liquidity). These diagrams simplify complexities such as the ones\ndiscussed in that analysis, but they give a sense of how ownership can be diluted.\n\n```hlwy-infographics\n{\n  \"name\": \"CaptableDilution\",\n  \"data\": {\n    \"hypothetical\": {\n      \"label\": \"Hypothetical\",\n      \"stages\": [\n        {\n          \"label\": \"Founding\",\n          \"postValuation\": 1000,\n          \"captable\": [\n            {\n              \"type\": \"founder1\",\n              \"label\": \"Founder #1\",\n              \"shares\": 4000000\n            },\n            {\n              \"type\": \"founder2\",\n              \"label\": \"Founder #2\",\n              \"shares\": 3000000\n            },\n            {\n              \"type\": \"founder3\",\n              \"label\": \"Founder #3\",\n              \"shares\": 3000000\n            }\n          ]\n        },\n        {\n          \"label\": \"Series A\",\n          \"captable\": [\n            {\n              \"type\": \"founder1\",\n              \"label\": \"Founder #1\",\n              \"shares\": 4000000\n            },\n            {\n              \"type\": \"founder2\",\n              \"label\": \"Founder #2\",\n              \"shares\": 3000000\n            },\n            {\n              \"type\": \"founder3\",\n              \"label\": \"Founder #3\",\n              \"shares\": 3000000\n            },\n            {\n              \"type\": \"options\",\n              \"label\": \"Options Pool\",\n              \"shares\": 1500000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Seed\",\n              \"preValuation\": 8000000,\n              \"raised\": 2000000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Series A\",\n              \"preValuation\": 8000000,\n              \"raised\": 5000000\n            }\n          ]\n        },\n        {\n          \"label\": \"Series C\",\n          \"captable\": [\n            {\n              \"type\": \"founder1\",\n              \"label\": \"Founder #1\",\n              \"shares\": 4000000\n            },\n            {\n              \"type\": \"founder2\",\n              \"label\": \"Founder #2\",\n              \"shares\": 3000000\n            },\n            {\n              \"type\": \"founder3\",\n              \"label\": \"Founder #3\",\n              \"shares\": 3000000\n            },\n            {\n              \"type\": \"options\",\n              \"label\": \"Options Pool\",\n              \"shares\": 1500000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Seed\",\n              \"preValuation\": 8000000,\n              \"raised\": 2000000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Series A\",\n              \"preValuation\": 8000000,\n              \"raised\": 5000000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Series B\",\n              \"preValuation\": 20000000,\n              \"raised\": 10000000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Series C\",\n              \"preValuation\": 40000000,\n              \"raised\": 20000000\n            }\n          ]\n        }\n      ]\n    },\n    \"zipcar\": {\n      \"label\": \"Approx. Zipcar\",\n      \"stages\": [\n        {\n          \"label\": \"Founding\",\n          \"postValuation\": 1000,\n          \"captable\": [\n            {\n              \"type\": \"founder1\",\n              \"label\": \"Founder #1\",\n              \"shares\": 570000\n            },\n            {\n              \"type\": \"founder2\",\n              \"label\": \"Founder #2\",\n              \"shares\": 570000\n            }\n          ]\n        },\n        {\n          \"label\": \"Series A\",\n          \"captable\": [\n            {\n              \"type\": \"founder1\",\n              \"label\": \"Founder #1\",\n              \"shares\": 570000\n            },\n            {\n              \"type\": \"founder2\",\n              \"label\": \"Founder #2\",\n              \"shares\": 570000\n            },\n            {\n              \"type\": \"options\",\n              \"label\": \"Options Pool\",\n              \"shares\": 378000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Series A\",\n              \"preValuation\": 5800000,\n              \"raised\": 1400000\n            }\n          ]\n        },\n        {\n          \"label\": \"Series B\",\n          \"captable\": [\n            {\n              \"type\": \"founder1\",\n              \"label\": \"Founder #1\",\n              \"shares\": 570000\n            },\n            {\n              \"type\": \"founder2\",\n              \"label\": \"Founder #2\",\n              \"shares\": 570000\n            },\n            {\n              \"type\": \"options\",\n              \"label\": \"Options Pool\",\n              \"shares\": 378000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Series A\",\n              \"preValuation\": 5800000,\n              \"raised\": 1400000\n            },\n            {\n              \"type\": \"investment\",\n              \"label\": \"Series A\",\n              \"preValuation\": 2200000,\n              \"raised\": 4700000\n            }\n          ]\n        }\n      ]\n    }\n  }\n}\n```\n\n### Stages of a Startup\n\nUnderstanding the value of stock and equity in a startup requires a grasp of the stages of\ngrowth a startup goes through.\nThese stages are largely reflected in how much funding has been raised—how much ownership,\nin the form of shares, has been sold for capital.\n\nVery roughly,\n[typical stages](http://blog.eladgil.com/2011/03/how-funding-rounds-differ-seed-series.html)\nare:\n\n- [**Bootstrapped**](https://www.investopedia.com/terms/b/bootstrapping.asp) (little funding or\n  self-funded): Founders are figuring out what to build, or they’re starting to build with\n  their own time and resources.\n- [**Series Seed**](https://www.investopedia.com/terms/s/seedcapital.asp) (roughly $250K to $2\n  million in funding): Figuring out the product and market.\n  The low end of this spectrum is now often called **pre-seed**.\n- [**Series A**](https://www.investopedia.com/terms/s/seriesa.asp) ($2 to $15 million): Scaling the\n  product and making the business model work.\n- [**Series B**](https://www.investopedia.com/terms/s/series-b-financing.asp) (tens of millions):\n  Scaling the business.\n- **Series C, D, E, et cetera** (tens to hundreds of millions): Continued scaling of the\n  business.\n\nKeep in mind that these numbers are more typical for startups located in California.\nThe amount raised at various stages is typically smaller for companies located outside of\nSilicon Valley, where what would be called a seed round may be called a Series A in, say,\nHouston, Denver, or Columbus, where there are fewer companies competing for investment\nfrom fewer venture firms, and costs associated with growth (including providing livable\nsalaries) are lower.[^nytimescom.bcfuyu][^chicagotri.fq0msp]\n\n🔸 Most startups don’t get far.\nAccording to an analysis of\n[angel investments](https://www.investopedia.com/terms/a/angelinvestor.asp), by Susa Ventures\ngeneral partner [Leo Polovets](http://codingvc.com), **more than half** of investments fail;\n**one in 3** are small successes (1X to 5X returns); **one in 8** are big successes (5X to\n30X); and **one in 20** are huge successes (30X+).[^codingvcco.bcspni]\n\n🚧 What are some stats beyond angel investments?\n\n🔸 Each stage reflects the reduction of risk and increased dilution.\nFor this reason, the amount of equity team members get is higher in the earlier stages\n(starting with founders) and increasingly lower as a company matures.\n(See the picture above.)\n\n### The Option Pool\n\n🄳 At some point early on, generally before the first employees are hired, a number of\nshares will be reserved for an employee\n**[option pool](http://www.investopedia.com/terms/o/option-pool.asp) (or employee pool)**. The\noption pool is part of a legal structure called an equity incentive plan.\nA typical size for the option pool is 20% of the stock of the company, but, especially for\nearlier stage companies, the option pool can be 10%, 15%, or other sizes.\n\nOnce the pool is established, the company’s board of directors grants stock from the pool\nto employees as they join the company.\n\n∑ Well-advised companies will reserve in the option pool only what they\n[expect to use](http://siliconhillslawyer.com/2014/05/01/option-pool-not-ocean-startups/) over\nthe next 12 months or so;\notherwise, given how equity grants are usually promised, they may be over-granting equity.\nThe whole pool may never be fully used, but companies should still try not to reserve more\nthan they plan to use.\nThe size of the pool is determined by\n[complex factors](http://venturehacks.com/articles/option-pool-shuffle) between founders and\ninvestors. It’s worth employees (and\n[founders](https://www.cooleygo.com/negotiating-option-pool/)) understanding that a small pool\ncan be a good thing in that it reflects the company preserving ownership in negotiations\nwith investors.\nThe size of the pool may be increased later.\n\n### Counting Shares\n\nThere are some key subtleties you’re likely to come across in the way\n[outstanding shares](#stock-and-shares) are counted:\n\n🄳 Private companies always have what are referred to as **authorized but unissued** shares,\nreferring to shares that are authorized in legal paperwork but have not actually been\nissued. Until they are issued, the\n[unissued stock](https://www.investopedia.com/terms/u/unissuedstock.asp) these shares\nrepresent doesn’t mean anything to the company or to shareholders:\nno one owns it.\n\n☝️ For example, a corporation might have 100 million *authorized* shares, but will only\nhave *issued* 10 million shares.\nIn this example, the corporation would have 90 million *authorized but unissued* shares.\nWhen you are trying to determine what percentage a number of shares represents, you do\n*not* make reference to the authorized but unissued shares.\n\n☝️ You actually want to know the total issued shares, but even this number can be\nconfusing, as it can be computed\n[more than one way](http://www.mattbartus.com/option-grants-fully-diluted-or-issued-and-outstanding/).\nTypically, people count shares in two ways: *issued and outstanding* and *fully diluted*.\n\n🄳 **Issued and outstanding** refers to the number of shares actually issued by a company to\nshareholders, and does not include shares that others may have an option to purchase.\n\n🄳 **Fully diluted** refers to all of the shares that a company has issued, all of the\nshares that have been set aside in a stock incentive plan, and all of the shares that\ncould be issued if all convertible securities (such as outstanding warrants) were\nexercised.\n\nA key difference between fully diluted shares and shares issued and outstanding is that\nthe total of fully diluted shares will include all the shares in the employee option pool\nthat are reserved but *not yet issued to* employees.\n\n🔹 If you’re trying to figure out the likely percentage a number of shares will be worth\nin the future, it’s best to know the number of shares that are fully diluted.\n\n∑ Even the fully diluted number may not take into account outstanding convertible\nsecurities (like convertible notes) that are *waiting* to be converted into stock at a\nfuture milestone.\nFor a more complete understanding, in addition to asking about the fully-diluted\ncapitalization you can ask about any convertible securities outstanding that are not\nincluded in that number.\n\n☝️ The terminology mentioned here isn’t universally applied.\nIt’s worth discussing these terms with your company to be sure you’re on the same page.\n\n🄳 A **capitalization table (cap table)** is a\n[table](https://www.investopedia.com/terms/c/capitalization-table.asp) (often a spreadsheet or\nother official record) that records the ownership stakes, including number and class of\nshares, of all shareholders in the company.\nIt is updated as stock is granted to new shareholders.[^cooleygoco.p5v68j]\n\n🚧 Better discuss future sources of dilution.\nDefine convertible securities and convertible notes and “[fully diluted](https://www.lawinsider.com/dictionary/fully-diluted-basis)”\nmore. Do people say “fully diluted” but not include convertible securities?\n\n### Classes of Stock\n\n🄳 Investors often ask for rights to be paid back first in exchange for their investment.\nThe way these different rights are handled is by creating different\n[**classes of stock**](https://www.upcounsel.com/classes-of-stock). (These are also sometimes\ncalled [**classes of shares**](https://www.investopedia.com/terms/c/class.asp), though that term\nhas another meaning in the context of mutual funds.)\n\n🄳 Two important classes of stock are\n[**common stock**](https://en.wikipedia.org/wiki/Common_stock) and\n[**preferred stock**](https://en.wikipedia.org/wiki/Preferred_stock). In general, preferred stock\nhas “[rights, preferences, and privileges](https://www.americanbar.org/groups/business_law/publications/blt/2014/01/04_bigler/)”\nthat common stock does not have.\nTypically, investors get preferred stock, and founders and employees get common stock (or\nstock options).\n\nThe exact number of classes of stock and the differences between them can vary company to\ncompany, and, in a startup, these can vary at [each round](#stages-of-a-startup) of funding.\n\n☝️ Another term you’re likely to hear is\n[*founders’ stock*](http://www.alleywatch.com/2013/08/what-is-founders-stock-legally/), which is\n(usually) common stock allocated at a company’s formation, but otherwise doesn’t have any\ndifferent rights from other common stock.[^lsvpwordpr.dgym96]\n\nAlthough preferred stock rights are too complex to cover fully, we can give a few key\ndetails:\n\n🄳 Preferred stock usually has a\n[**liquidation preference (or preference)**](http://www.investopedia.com/terms/l/liquidation-preference.asp),\nmeaning the preferred stock owners will be paid before the common stock owners when a\n[liquidity event](#sales-and-liquidity) occurs, such as if the company is sold or goes public.\n\n🄳 A company is in\n[**liquidation overhang**](https://equityzen.com/blog/startup-valuations-and-liquidation-preference-overhang/)\nwhen the value of the company doesn’t reach the dollar amount investors put into it.\nBecause of liquidation preference, those holding preferred stock (investors) will have to\nbe paid before those holding common stock (employees).\nIf investors have put millions of dollars into a company and it’s sold, employees’ equity\nwon’t be worth anything if the company is in liquidation overhang and the sale doesn’t\nexceed that amount.[^avccom2010.zxzhsl]\n\n☝️ The complexities of the liquidation preference are\n[infamous](https://venturebeat.com/2010/08/16/beware-the-trappings-of-liquidation-preference/).\nIt’s worth understanding that investors and entrepreneurs negotiate a lot of the details\naround preferences, including:\n\n- The *multiple*, a number designating how many times the investor must be paid back before\n  common shareholders receive proceeds.\n  (Often the multiple is 1X, but it can be 2X or higher.)\n\n- Whether preferred stock is\n  [*participating*](https://en.wikipedia.org/wiki/Participating_preferred_stock), meaning\n  investors get their money back and also participate in proceeds from common stock.\n\n- Whether there is a *cap*, which limits the payout if it is participating.\n\n- ∑\n  [🔑This primer](https://medium.com/@CharlesYu/the-ultimate-guide-to-liquidation-preferences-478dda9f9332)\n  by Charles Yu gives a concise overview.\n  Founders and companies are affected significantly and in subtle ways by these\n  considerations.\n  For example, as lawyer José Ancer points out, common and preferred stockholders are\n  typically quite different and their incentives\n  [sometimes](http://siliconhillslawyer.com/2017/10/13/common-stock-v-preferred-stock/)\n  [diverge](http://siliconhillslawyer.com/2018/02/07/board-works-common-stock/).\n\n- 🚧 What are good resources to mention that describe conversion of preferred stock to\n  common stock?\n\n🔹 For the **purposes of an employee who holds common stock**, the most important thing to\nunderstand about preferences is that they’re not likely to matter if a company does well\nin the long term.\nIn that case, every stockholder has valuable stock they can eventually sell.\nBut if a company fails or [exits](#sales-and-liquidity) for less than investors had hoped,\nthe preferred stockholders are generally first in line to be paid back.\nDepending on how favorable the terms are for the investor, if the company exits at a low\nor modest valuation, it’s likely that common shareholders will receive little—or nothing\nat all.\n\n## How Equity Is Granted\n\nIn this section we’ll lay out how equity is granted in practice, including the\ndifferences, benefits, and drawbacks of common types of equity compensation, including\nrestricted stock awards, stock options, and restricted stock units (RSUs).\nWe’ll go over a few less common types as well.\nWhile the [intent](#the-goals-of-equity-compensation) of each kind of equity grant is\nsimilar, they differ in many ways, particularly around how they are\n[taxed](#taxes-on-equity-compensation).\n\nExcept in rare cases where it may be negotiable, the type of equity you get is up to the\ncompany you work for.\nIn general, larger companies grant RSUs, and startups grant stock options, and\noccasionally executives and very early employees get restricted stock awards.\n\n🚧 Add section on when equity is granted, including plus-ups.\n\n### Restricted Stock Awards\n\nAt face value, the most direct approach to equity compensation would be for the company to\naward stock to an employee in exchange for work.\nIn practice, it turns out a company will only want to do this with restrictions on how and\nwhen the stock is fully owned.\n\nEven so, this is actually one of the least common ways to get equity.\nWe mention it first because it is the simplest form of equity compensation, useful for\ncomparison as things get more complex.\n\n🄳 A **restricted stock award** is when a company grants someone stock as a form of\ncompensation. The stock awarded has additional conditions on it, including a vesting\nschedule, so is called **restricted stock**. Restricted stock awards may also be called\nsimply **stock awards** or **stock grants**.\n\n∑ What *restricted* means here is actually\n[complex](https://github.com/jlevy/og-equity-compensation/issues/24). It refers to the fact\nthat the stock (i) has certain restrictions on it (like transfer restrictions) required\nfor private company stock, and (ii) will be subject to repurchase at cost pursuant to a\nvesting schedule.\nThe repurchase right lapses over the service-based vesting period, which is what is meant\nin this case by the stock “vesting.”\n\n☝️ Restricted stock awards are\n[not the same](https://www.fool.com/knowledge-center/the-difference-between-a-restricted-stock-unit-res.aspx)\nthing as restricted stock units.\n\nTypically, stock awards are limited to executives or very early hires, since once the\nvalue of the shares increases, the tax burden of receiving them (without paying the\ncompany for their value) can be too great for most people.\nUsually, instead of restricted stock, an employee will get stock options.\n\n### Stock Options\n\n🄳 [**Stock options**](https://en.wikipedia.org/wiki/Employee_stock_option) are contracts that\nallow individuals to buy a specified number of shares in the company they work for at a\nfixed price. Stock options are the most common way early-stage companies grant equity.\n\n🄳 A person who has received a stock option grant is not a shareholder until they\n**exercise** their option, which means purchasing some or all of their shares at the strike\nprice. Prior to exercising, an option holder does not have voting rights.\n\n🄳 The **strike price (or exercise price)** is the fixed price per share at which stock can\nbe purchased, as set in a stock option agreement.\nThe strike price is generally set lower (often much lower) than what people expect will be\nthe *future* value of the stock, which means selling the stock down the road could be\nprofitable.\n\n☝️ *Stock options* is a confusing term.\nIn investment, an *option* is a right (but not an obligation) to buy something at a\ncertain price within a certain time frame.\nYou’ll often see stock options discussed in the context of\n[investment](https://www.investopedia.com/terms/s/stockoption.asp). What investors in\nfinancial markets call *stock options* are indeed options on stock, but they are not\n*compensatory* stock options awarded for services.\nIn this Guide, and most likely in any conversation you have with an employer, anyone who\nsays “stock options” will be referring to compensatory stock options.\n\n☝️ Stock options are not the same as stock;\nthey are only the *right to buy stock* at a certain price and under a set of conditions\nspecified in an employee’s stock option agreement.\nWe’ll get into these conditions next.\n\n∑ Although everyone typically refers to “stock options” in the plural, when you receive a\nstock option grant, you are receiving *an option* to purchase a given number of shares.\nSo technically, it’s incorrect to say someone “has 10,000 stock options.”\n\nIt’s best to understand the financial and [tax implications](#taxes-on-isos-and-nsos) before\ndeciding [when to exercise](#stock-option-scenarios) options.\nIn order for the option to be tax-free to receive, the strike price must be the fair\nmarket value of the stock on the date the option is granted.\n\n∑ Those familiar with\n[stock trading](https://www.investopedia.com/university/stocks/stocks3.asp) (or those with\neconomics degrees) will tell you about the\n[**Black-Scholes model**](https://www.investopedia.com/university/options-pricing/black-scholes-model.asp),\na general mathematical model for determining the value of options.\nWhile theoretically sound, this does not have as much practical application in the context\nof employee stock options.\n\n🚧 Any real-world examples or statistics of how low strike price has led to big payoffs?\nAlso we could mention and relate this to the term *employee stock options (or ESOs)* and\ndispel any confusion between ESOs and ESPPs.\n\n### Vesting and Cliffs\n\n🄳 **Vesting** is the process of gaining full legal rights to something.\nIn the context of compensation, founders, executives, and employees typically gain rights\nto their grant of equity incrementally over time, subject to restrictions.\nPeople may refer to their shares or stock options vesting, or may say that a person is\nvesting or has fully vested.\n\n🄳 In the majority of cases, vesting occurs incrementally over time, according to a\n**vesting schedule**. A person vests only while they work for the company.\nIf the person quits or is terminated immediately, they get no equity, and if they stay for\nyears, they’ll get most or all of it.\n\nAwards of stock, stock options, and RSUs are almost always subject to a vesting schedule.\n\n🄳 Vesting schedules can have a **cliff** designating a length of time that a person must\nwork before they vest at all.\n\nFor example, if your equity award had a one-year cliff and you only worked for the company\nfor 11 months, you would not get anything, since you haven’t vested in any part of your\naward. Similarly, if the company is sold within a year of your arrival, depending on what\nyour paperwork says, you may receive nothing on the sale of the company.\n\nA very common vesting schedule is vesting over **4 years**, with a **1 year** cliff.\nThis means you get 0% vesting for the first 12 months, 25% vesting at the 12th month, and\n1/48th (2.08%) more vesting each month until the 48th month.\nIf you leave just before a year is up, you get nothing, but if you leave after 3 years,\nyou get 75%.\n\n🄳 In some cases, vesting may be triggered by specific events outside of the vesting\nschedule, according to contractual terms called **accelerated vesting (or acceleration)**.\nTwo kinds of accelerated vesting that are commonly negotiated are if the company is sold\nor undergoes a merger (**single trigger**) or if it’s sold and the person is fired (**double\ntrigger**).\n\n🌪 Cliffs are an important topic.\nWhen they work well, cliffs are an effective and reasonably fair system to both employees\nand companies.\nBut they can be abused and their complexity can lead to misunderstandings:\n\n- The intention of a cliff is to make sure new hires are committed to staying with the\n  company for a significant period of time.\n  However, the flip side of vesting with cliffs is that if an employee is leaving—quits or\n  is laid off or fired—just short of their cliff, they may walk away with no stock ownership\n  at all, sometimes through no fault of their own, as in the event of a family emergency or\n  illness. In situations where companies fire or lay off employees just before a cliff, it\n  can easily lead to hard feelings and even lawsuits (especially if the company is doing\n  well enough that the stock is worth a lot of money).[^inccombusi.oldydy][^bloombergc.a48epn]\n- 🔹 As a manager or founder, if an employee is performing poorly or may have to be laid\n  off, it’s both thoughtful and wise to let them know what’s going on well before their\n  cliff.\n- ∑ Founders often have vesting on their stock themselves.\n  As entrepreneur Dan Shapiro explains, this is often for\n  [good reason](http://www.danshapiro.com/blog/2012/04/vesting-is-a-hack/).\n- 🔹 As an employee, if you’re leaving or considering leaving a company before your vesting\n  cliff is met, consider waiting.\n  Or, if your value to the company is high enough, you might\n  [negotiate](https://www.businessinsider.com/everything-you-need-to-know-about-cliff-vesting-2011-5)\n  to get some of your stock “[vested up](https://www.foley.com/when-should-vesting-of-equity-grants-accelerate-06-19-2014/)”\n  early. Your manager may well agree that is is fair for someone who has added a lot of\n  value to the company to own stock even if they leave earlier than expected, especially for\n  something like a family emergency.\n  These kinds of vesting accelerations are entirely discretionary, however, unless you\n  negotiated for special acceleration in an employment agreement.\n  Such special acceleration rights are typically reserved for executives who negotiate their\n  employment offers heavily.\n- 🚧 How does taking time off, for example a leave of absence, affect the vesting schedule?\n- Acceleration when a company is sold (called\n  [*change of control*](http://stockoptioncounsel.com/blog/change-of-control-terms-for-startup-stock-options-restricted-stock-and-rsus/2018/6/4)\n  terms) is common for founders and not so common for employees.\n  It’s worth understanding acceleration and triggers in case they show up in your option\n  agreement, but these may not be something you can negotiate unless you are going to be in\n  a key role.\n- Companies may impose additional restrictions on stock that is vested.\n  For example, your shares are very likely subject to a right of first refusal, which means\n  that you can’t sell the stock without offering it first to the company.\n  And it can happen that companies reserve the right to\n  [repurchase](https://www.forbes.com/sites/dianahembree/2018/01/10/startup-employee-alert-can-your-company-take-back-your-vested-stock-options/#75fb48ee6e49)\n  vested shares in certain events.\n\n🚧 Can we give any examples here?\n\n### How Options Expire\n\n🄳 The **exercise window (or exercise period)** is the period during which a person can buy\nshares at the strike price.\nOptions are only exercisable for a fixed period of time, until they expire, typically\nseven to ten years as long as the person is working for the company.\nBut this window is not always open.\n\n❗ **Expiration after termination.**\nOptions can expire after you quit working for the company.\nOften, the expiration is **90 days** after termination of service, making the options\neffectively worthless if you cannot exercise before that point.\nAs we’ll get into later, you need to understand the costs, [taxes](#taxes-on-isos-and-nsos),\nand tax [liabilities](#the-amt-trap) of exercise and to plan ahead.\nIn fact, you can find out when you are granted the options, or better yet, before you sign\nan offer letter.\n\n🔹 **Longer exercise windows.**\nRecently (since around 2015) a few companies are finding ways to keep the exercise window\nopen for years after leaving a company, promoting this practice as fairer to employees.\nCompanies with\n[extended exercise windows](https://github.com/holman/extended-exercise-windows) include\nAmplitude,[^amplitudec.fvea8b] Clef,[^githubcomc.ygtolb] Coinbase,[^mediumcomb.nqs9mo] Pinterest,[^fortunecom.nnfd6o] and Quora.[^quoracomwh.4dxi02]\nHowever, the 90-day exercise window remains the norm.\n\n🌪 **The exercise window debate.**\nWhether to have extended exercise windows has been debated at significant length.\nSome believe extended exercise windows are\n[the future](https://triplebyte.com/blog/extending-stock-option-exercise-window-guide#.12rv7ovrv),\narguing that a shorter window makes a company’s success a\n[punishment](http://stockoptioncounsel.com/blog/nc7go8ivzxb1el5rhv6nltrjan0n2t/2017/3/6) to\nearly employees.\n\nKey considerations include:\n\n- Everyone agrees that employees holding stock options with an expiring window often have to\n  make a painful choice if they wish to leave:\n  Pay for a substantial tax bill (perhaps five to seven figures) on top of the cost to\n  exercise (possibly looking for [secondary liquidity or a loan](#can-you-sell-private-stock))\n  or walk away from the options.\n- Many familiar with this situation have spoken out\n  [forcefully](https://zachholman.com/posts/fuck-your-90-day-exercise-window/) against shorter\n  exercise windows, arguing that an employee can help grow the value of a company\n  substantially—often having taken a lower salary in exchange for equity—but end up with\n  [no ownership](https://triplebyte.com/blog/fixing-the-inequity-of-startup-equity) because\n  they’re unable or unwilling to stay for the several years [typically needed](#ipos) before an\n  IPO or sale.\n- On the other side, a few companies and investors\n  [stand by](https://a16z.com/2016/06/23/options-timing/) the existing system, arguing that it\n  is better to incentivize people not to leave a company, or that long windows effectively\n  transfer wealth from employees who commit long-term to those who leave.\n- Some focused on the legalities also argue that it’s a legal requirement of ISOs to have a\n  90-day exercise window.\n  While this is technically true, it’s not the\n  [whole story](https://news.ycombinator.com/item?id=9254299). It is possible for companies to\n  extend the exercise window by changing the nature of the options (converting them from\n  ISOs to NSOs) and [many companies](https://github.com/holman/extended-exercise-windows) now\n  choose to do just that.\n- Another path is to\n  [split the difference](http://stockoptioncounsel.com/blog/early-expiration-of-startup-stock-options-part-2-the-full-10-year-term-solution/2017/3/28)\n  and give extended windows only to longer-term employees.\n- Taken together, it’s evident many employees have not been clear on the nuances of this\n  when joining companies, and some have\n  [🔑suffered](https://medium.com/@ben_mathes/90-days-and-my-six-figure-mistake-a495f4a188e2)\n  because of it.\n  With the risks of short exercise windows for employees becoming more widely known, longer\n  exercise windows are gradually becoming more prevalent.\n  As an employee or a founder, it is fairer and wiser to understand and negotiate these\n  things up front, and avoid unfortunate surprises.\n\n☝️ Options granted to advisors typically vest over a shorter period than employee grants,\noften one to two years.\nAdvisor grants also typically have a longer exercise window post termination of service,\nand will usually have single trigger acceleration on an acquisition, because no one\nexpects advisors to stay on with a company once it’s acquired.\nTypical terms for advisors, including equity levels, are available in the\n[📥Founder/Advisor Standard Template (FAST)](https://fi.co/contents/fast#), from the Founder\nInstitute.\n\n### Kinds of Stock Options\n\n🄳 Compensatory stock options come in two flavors, **incentive stock options (ISOs)** and\n**non-qualifying stock options (NQOs, or NQSOs)**. Confusingly, lawyers and the IRS use\n[several names](https://www.irs.gov/taxtopics/tc427) for these two kinds of stock options,\nincluding **statutory stock options** and **non-statutory stock options (or NSOs)**,\nrespectively.\n\nIn this Guide, we refer to ISOs and NSOs.\n\n| Type | Also called |\n| - | - |\n| Statutory | Incentive stock option, ISO |\n| Non-statutory | Non-qualifying stock option, NQO, NQSO, NSO |\n\n- Companies generally decide to give ISOs or NSOs depending on the legal advice they get.\n  It’s rarely up to the employee which they will receive, so it’s best to know about both.\n  There are pros and cons of each from both the recipient’s and the company’s perspective.\n- ISOs are common for employees because they have the possibility of being more favorable\n  from a tax point of view than NSOs.\n- 🔸 ISOs can only be granted to employees (not independent contractors or directors who are\n  not also employees).\n- But ISOs have a number of limitations and conditions and can also create difficult\n  [tax consequences](#taxes-on-isos-and-nsos).\n\n### Early Exercise\n\n🄳 Sometimes, to help reduce the tax burden on stock options, a company will make it\npossible for option holders to **early exercise (or forward exercise)** their options, which\nmeans they can exercise even before they vest.\nThe option holder becomes a stockholder sooner, after which the vesting applies to actual\nstock rather than options.\nThis will have [tax implications](#83b-elections).\n\n🔸 However, the company has the right to repurchase the *unvested* shares, at the price\npaid or at the fair market value of the shares (whichever is lower), if a person quits\nworking for the company.\nThe company will typically repurchase the unvested shares should the person leave the\ncompany before the stock they’ve purchased vests.\n\n### Restricted Stock Units\n\nWhile stock options are the most common form of equity compensation in smaller private\ncompanies, RSUs have become the most common type of equity award for public and large\nprivate companies.\nFacebook pioneered the use of RSUs as a private company to allow it to avoid having to\nregister as a public company earlier.\n\n🚧 Why? More links on history of RSUs and Facebook story?\n\n🄳\n[**Restricted stock units (RSUs)**](http://www.investopedia.com/terms/r/restricted-stock-unit.asp)\nrefer to an agreement by a company to issue an employee shares of stock or the cash value\nof shares of stock on a future date.\nEach unit represents one share of stock or the cash value of one share of stock that the\nemployee will receive in the future.\n(They’re called *units* since they are neither stock nor stock options, but another thing\naltogether that is contractually linked to the value of stock.)\n\n🄳 The date on which an employee receives the shares or cash payment for RSUs is known as\nthe **settlement date**.\n\n- 🔸 RSUs may vest according to a vesting schedule.\n  The settlement date may be the time-based vesting date or a later date based on, for\n  instance, the date of a company’s IPO.\n- RSUs are difficult in a startup or early stage company because when the RSUs vest, the\n  value of the shares might be significant, and taxes will be owed on the receipt of the\n  shares.[^thestartup.tn6iyt] This is not a bad result when the company has sufficient capital to help the\n  employee make the tax payments, or the company is a public company that has put in place a\n  program for selling shares to pay the taxes.\n  But for cash-strapped private startups, neither of these are possibilities.\n  This is the reason most startups use stock options rather than RSUs or stock awards.\n- RSUs are often considered less preferable to grantees since they remove control over when\n  you owe tax. Options, if granted with an exercise price equal to the fair market value of\n  the stock, are not taxed until exercise, an event under the control of the optionee.\n  If an employee is awarded an RSU or restricted stock award which vests over time, they\n  will be taxed on the vesting schedule;\n  they have been put on “autopilot” with respect to the timing of the tax event.\n  If the shares are worth a lot on the date of vesting, the tax burden can be significant.\n- ☝️ You don’t want to confuse *restricted stock units* with *restricted stock*, which\n  typically refers to restricted stock awards.\n\n### Less Common Types of Equity\n\nWhile most employee equity compensation takes the form of stock, stock options, or RSUs, a\ncomplete tour of equity compensation must mention a few less common forms.\n\n🄳 **Phantom equity** is a type of compensation award that references equity, but does not\nentitle the recipient to actual ownership in a company.\nThese awards come under a variety of different monikers, but the key to understanding them\nis knowing that they are really just cash bonus plans, where the cash amounts are\ndetermined by reference to a company’s stock.\nPhantom equity can have significant value, but may be perceived as less valuable by\nworkers because of the contractual nature of the promises.\nPhantom equity plans can be set up as purely discretionary bonus plans, which is less\nattractive than owning a piece of something.\n\nTwo examples of phantom equity are phantom stock and stock appreciation rights:\n\n🄳 A\n[**phantom stock**](http://www.investopedia.com/articles/stocks/12/introduction-phantom-stock.asp)\naward is a type of phantom equity that entitles the recipient to a payment equal to the\nvalue of a share of the company’s stock, upon the occurrence of certain events.\n\n🄳\n[**Stock appreciation rights (SARs)**](https://www.nceo.org/articles/phantom-stock-appreciation-rights-sars)\nare a type of phantom equity that gives the recipient the right to receive a payment\ncalculated by reference to the appreciation in the equity of the company.\n\n🚧 Elaboration needed on what events typically trigger phantom stock.\nMore data on how rare these are?\nAnd what is appreciation?\n\n🄳 [**Warrants**](https://en.wikipedia.org/wiki/Warrant_%28finance%29) are another kind of option\nto purchase stock, generally used in investment transactions (for example, in a\nconvertible note offering, investors may also get a warrant, or a law firm may ask for one\nin exchange for vendor financing).\nThey differ from stock options in that they are more abbreviated and stand-alone legal\ndocuments, not granted pursuant to a single legal agreement (typically called a “[plan](#documents-and-agreements)”)\nfor all employees.\n\nEmployees and advisors may not encounter warrants, but it’s worth knowing they exist.\n\n## Tax Basics\n\nThe awarding of equity compensation can give rise to multiple types of taxes for the\nrecipient, including federal and state income taxes and employment taxes.\nThere’s a lot that you have to be aware of. [Skip ahead](#taxes-on-equity-compensation) to\nunderstand how taxes on equity work, but if you have time, this section gives a technical\nsummary of tax fundamentals, just in case you never really figured out all the numbers on\nyour pay stub.\n\nYou don’t need to know every detail, and can rely on software and professionals to\ndetermine the tax you owe, but we do suggest understanding the different kinds of taxes,\nhow large they can be, and how each is “triggered” by different events.\n\nGiven the complexity, most taxpayers aren’t aware of exactly how their tax is calculated.\nIt does take up thousands of pages[^slatecomar.qqwwen] of the federal tax code and involves the intricate\ndiversity of state tax law as well.[^gpogovfdsy.clz3vr]\n\n☝️ If you’re already familiar with tax terminology, this section may not have any major\nsurprises. But for those who are not used to it, watch out:\nMany terms sound like regular English, but they’re not. *Ordinary income*, *long-term* and\n*short-term*, *election*, *qualified small business*, and other phrases have very specific\nmeanings we’ll do our best to spell out.\n\n### Kinds of Income\n\n🄳 **Income** is the money an individual makes.\nFor tax purposes, there are two main types of income, which are taxed differently.\n[**Ordinary income**](https://www.investopedia.com/terms/o/ordinaryincome.asp) includes wages,\nsalary, bonuses and interest made on investments.\n[**Capital gains**](https://www.investopedia.com/terms/c/capital_gains_tax.asp) are the profits an\nindividual makes from selling assets, including stock.\n\nOne key difference between ordinary income and capital gains is that when capital gains\ntaxes are calculated, consideration is given not just to the sale price of the asset but\nto the total gain or loss the investment incurred, each outcome having significantly\ndifferent tax consequences.\n\n🄳 Capital gains are classified as long-term or short-term. **Long-term capital gains** are\nthe profits an individual makes from selling assets, such as stock, a business, a house,\nor land, that were held for more than a year. **Short-term capital gains** are profits from\nthe sale of assets held for less than a year.\n\nAlthough this topic is not without\n[💰controversy](https://www.wsj.com/articles/how-should-capital-gains-be-taxed-1425271052),\nthe general idea is, if you are selling something you’ve owned for a long time, you can be\ntaxed a lower rate.\n\nAll these rates have evolved over time based on economic and political factors,[^taxpolicyc.sjye20] so you\ncan be confident they will change again in the future.\n\n📰 In 2017, Congress passed the\n[Tax Cuts and Jobs Act](https://en.wikipedia.org/wiki/Tax_Cuts_and_Jobs_Act_of_2017) (TCJA),\nwhich made\n[many changes](https://heritageinvestment.com/wp-content/uploads/2018/01/TCJA-HIG-Old-vs.-New-Comparison.pdf)\nto tax rates for the **2018** tax year.\nLong-term capital gains taxes did\n[not change](https://www.marketwatch.com/story/your-simple-guide-to-the-new-capital-gains-tax-rates-2018-04-16)\nsignificantly.\n\n🚧 Can we clarify the term *investment income* too?\n\n### Federal Taxes\n\n🄳 **Income tax** is the money paid by individuals to federal, state, and, in some cases,\nlocal governments, and includes taxation of ordinary income and capital gains.\nGenerally, U.S. citizens, residents, and some\n[foreigners](https://www.irs.gov/individuals/international-taxpayers/nra-withholding) must\n[file](https://www.irs.gov/pub/irs-pdf/p17.pdf) and pay federal income tax.\n\n🔹 In general, federal tax applies to many\n[kinds of income](https://www.irs.gov/taxtopics/tc400.html). If you’re an employee at a\nstartup, you need to consider four kinds of federal tax, each of which is computed\ndifferently.\n\n☝️ When it comes to equity compensation, it’s possible that you’ll have to worry about\n*all of these*, depending on your situation.\nThat’s why we have a lot to cover here:\n\n🄳 **Ordinary income tax** is the tax on wages or salary income, and short-term investment\nincome. The term **short-term capital gains tax** may be applied to taxes on assets sold\nless than a year from purchase, but profits from these sales are taxed as ordinary income.\nFor a lot of people who make most of their money by working, ordinary income tax is the\nbiggest chunk of tax they pay.\n\n🄳 **Employment taxes** are an additional kind of federal tax beyond ordinary income tax,\nand consist of Social Security and\n[Medicare taxes](https://www.irs.gov/businesses/small-businesses-self-employed/questions-and-answers-for-the-additional-medicare-tax)\nthat are withheld from a person’s paycheck.\nEmployment taxes are also referred to as\n[**payroll taxes**](https://en.wikipedia.org/wiki/Payroll_tax) as they often show up on employee\npay stubs. The Social Security wage withholding rate in 2018 is 6.2% up to the FICA wage\nbase. The Medicare component is 1.45%, and it does not phase out above the FICA wage base.\n\n- 🚧 Review and add more links on SS and Medicare taxes.\n\n🄳 **Long-term capital gains tax** is a tax on the sale of assets held longer than a year.\nLong-term capital gains tax is often lower than ordinary income tax.\nMany investors hold assets for longer than a year in order to qualify for the lesser tax\nburden of long-term capital gains.\n\n🄳 **Alternative minimum tax (AMT)** is a\n[supplemental income tax](https://en.wikipedia.org/wiki/Alternative_minimum_tax) that applies\nto certain individuals in some situations.\nThis type of tax does not come up for many taxpayers, but higher income earners and people\nin special situations may have to pay large AMT bills.\nAMT was first enacted in 1979 in response to reports that 155 wealthy individuals had paid\nno income tax in 1966.[^taxpolicyc.mgorf1] It is not the same as ordinary income tax or employment tax, and\nis calculated according to its\n[own rules](https://www.nerdwallet.com/blog/taxes/alternative-minimum-tax-amt/).\n\n🚧 What is the history and motivation of AMT?\n\n❗ AMT is relevant to you if you’re reading this.\nIt’s important to understand because exercising ISOs can trigger AMT. In some cases a *lot*\nof AMT, *even when you haven’t sold the stock* and have no money to pay.\nWe discuss this [later](#the-amt-trap).\n\n#### Figure: Bracke Rates, Income, and Taxes\n\n```hlwy-infographics\n{\n  \"name\": \"TaxRates\",\n  \"data\": {\n    \"rates\": [\n      {\n        \"rate\": 0.1,\n        \"single\": 0,\n        \"married\": 0,\n        \"hoh\": 0\n      },\n      {\n        \"rate\": 0.12,\n        \"single\": 9525,\n        \"married\": 19050,\n        \"hoh\": 13600\n      },\n      {\n        \"rate\": 0.22,\n        \"single\": 38700,\n        \"married\": 77400,\n        \"hoh\": 51800\n      },\n      {\n        \"rate\": 0.24,\n        \"single\": 82500,\n        \"married\": 165000,\n        \"hoh\": 82500\n      },\n      {\n        \"rate\": 0.32,\n        \"single\": 157500,\n        \"married\": 315000,\n        \"hoh\": 157500\n      },\n      {\n        \"rate\": 0.35,\n        \"single\": 200000,\n        \"married\": 400000,\n        \"hoh\": 200000\n      },\n      {\n        \"rate\": 0.37,\n        \"single\": 500000,\n        \"married\": 600000,\n        \"hoh\": 500000\n      }\n    ],\n    \"deductions\": {\n      \"single\": 0,\n      \"married\": 0,\n      \"hoh\": 0\n    }\n  }\n}\n```\n\n```hlwy-infographics\n{\n  \"name\": \"TaxRates\",\n  \"data\": {\n    \"rates\": [\n      {\n        \"rate\": 0,\n        \"single\": 0,\n        \"married\": 0,\n        \"hoh\": 0\n      },\n      {\n        \"rate\": 0.15,\n        \"single\": 38600,\n        \"married\": 77200,\n        \"hoh\": 51700\n      },\n      {\n        \"rate\": 0.2,\n        \"single\": 425801,\n        \"married\": 479001,\n        \"hoh\": 452401\n      }\n    ],\n    \"deductions\": {\n      \"single\": 0,\n      \"married\": 0,\n      \"hoh\": 0\n    }\n  }\n}\n```\n\n🄴 *Source: IRS and the\n[Tax Foundation](https://files.taxfoundation.org/20180207142513/TaxFoundation-FF567-Updated.pdf)*\n\nA bit on how all this fits together:\n\n- Ordinary income tax applies in the situations you’re probably already familiar with, where\n  you pay taxes on [salaries or wages](https://www.irs.gov/taxtopics/tc401.html). Tax rates are\n  based on [filing status](https://www.irs.gov/newsroom/choosing-the-correct-filing-status) (if\n  you are single, married, or support a family), and on which\n  [**income bracket**](https://taxfoundation.org/2018-tax-brackets) you fall under.\n- **Income brackets.**\n  For ordinary income, as of the **2018** tax year, there are income brackets at **10%**, **12%**,\n  **22%**, **24%**, **32%**, **35%**, and **37%**\n  [marginal tax rates](http://www.investopedia.com/terms/m/marginaltaxrate.asp)—see\n  [Notice 1036](https://www.irs.gov/pub/irs-pdf/n1036.pdf) or a Tax Foundation\n  [summary](https://files.taxfoundation.org/20180207142513/TaxFoundation-FF567-Updated.pdf). Be\n  sure you understand how these brackets work, and what bracket you’re likely to be in.\n  - ☝️ There is a popular misconception that if you move to a higher bracket, you’ll make less\n    money.[^todayyougo.tyjmz8] What actually happens is when you cross certain thresholds, each additional\n    (marginal) dollar you make is taxed at a slightly higher rate, equal to the bracket you’re\n    in. After you earn more than your deduction, on which you pay no tax, your post-tax income\n    looks like the diagram above.\n    (More discussion on such misconceptions are in\n    [this Reddit thread](https://www.reddit.com/r/personalfinance/comments/2wkbgz/graphing_one_misconception_about_tax_brackets/).)\n- Investment gains, such as buying and selling a stock, are similarly taxed at “ordinary”\n  rates, unless they are [**long-term**](https://www.irs.gov/taxtopics/tc409.html), which means you\n  held the asset for more than a year.\n- You also pay a number of other federal taxes (see a\n  [📥2018 summary for all states](https://www.adp.com/tools-and-resources/compliance-connection/state-taxes/2018-fast-wage-and-tax-facts.aspx)),\n  notably:\n  - **6.2%** for Social Security on your first $118,500\n  - **1.45%** for Medicare\n  - **0.9%**\n    [Additional Medicare Tax](https://www.irs.gov/Businesses/Small-Businesses-\u0026-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax)\n    on income over $200,000 (single) or $250,000 (married filing jointly)\n  - **3.8%**\n    [Net Investment Income Tax](https://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs)\n    (NII) (enacted as part of the Affordable Care Act,[^taxpolicyc.w7dds7] also called “Obamacare”) on\n    investment income if you make over $200,000 (single) or $250,000 (married filing jointly).[^investoped.s08hcp]\n- Ordinary federal income tax, Social Security, and Medicare taxes are withheld from your\n  paycheck by your employer and are called\n  [**employment taxes**](https://www.irs.gov/Businesses/Small-Businesses-\u0026-Self-Employed/Understanding-Employment-Taxes).\n- 🔹 Long-term capital gains are taxed at a lower rate than ordinary income tax: **0%**, **15%**,\n  or **20%**.[^foolcomtax.ox10ej] This covers cases where you get dividends or sell stock after holding it a\n  year. If you are in the middle brackets (more than about $37K and less than $413K of\n  ordinary income), your long-term capital gains rate is 15%. You can find more detail on\n  tax brackets at the [Tax Foundation](https://taxfoundation.org/2018-tax-brackets/).\n- [AMT](http://fairmark.com/general-taxation/alternative-minimum-tax/alternative-minimum-tax-101/)\n  is a [complex part](https://www.irs.gov/taxtopics/tc556.html) of the federal tax code most\n  taxpayers don’t worry about.\n  But it comes into play when [exercising ISOs](#the-amt-trap). Most people do not pay AMT\n  unless it is “triggered” by specific\n  [situations](https://www.marketwatch.com/story/meet-the-new-friendlier-alternative-minimum-tax-2018-02-26),\n  typically high income (more than $500K) or high deductions.\n  Whether you pay AMT also depends on the state in which you file, since your state taxes\n  can significantly affect your deductions.\n  If you are affected, AMT tax rates are usually at **26%** or **28%** marginal tax rate, but\n  effectively **35%** for some ranges, meaning it is higher than ordinary income tax for some\n  incomes and lower for others.[^foolcomtax.3ka4p1]\n  AMT rules are so complicated you often need professional tax help if they might apply to\n  you. The IRS’s\n  [AMT Assistant](https://www.irs.gov/Businesses/Small-Businesses-\u0026-Self-Employed/Alternative-Minimum-Tax-(AMT)-Assistant-for-Individuals)\n  might also help.\n- 🔹 [Section 1202](https://www.investopedia.com/terms/s/section-1202.asp) of the Internal\n  Revenue Code provides a special tax break for qualified small business stock held for more\n  than five years.[^blogwealth.3vcf24]\n  Currently, this tax break is a 100% exclusion from income for up to $10M in gain.\n  There are also special rules that enable you to rollover gain on qualified small business\n  stock you have held for less than five years.\n  Stock received on the exercise of options can qualify for the Section 1202 stock benefit.\n- 🚧 Fill in details on QSBS. Move this elsewhere?\n  Good readings on this?\n\n### State Taxes\n\nState tax rates and rules\n[vary significantly](https://taxfoundation.org/state-individual-income-tax-rates-brackets-2018/).\nSince federal rates are much higher than state rates, you usually think of federal tax\nplanning first.\nBut you should also know a bit about tax rates in your state.\n\nState long-term capital gains rates range widely.\nCalifornia has the highest, at **13.3%**; several states have none.[^foolcomper.bw6uel]\n\n🔹 For this reason, some people even\n[consider moving](https://www.forbes.com/sites/robertwood/2016/05/17/can-you-avoid-california-taxes-by-moving/#316bd9471694)\nto another state if they are likely to have a windfall gain, like selling a lot of stock\nafter an IPO.\n\n🚧 How do you determine to what state you owe taxes?\nAny good resources on this?\n\n## Taxes on Equity Compensation\n\nEquity and taxes interact in complicated ways, and the tax consequences for an employee\nreceiving restricted stock, stock options, or RSUs are dramatically different.\nThis section will cover these messy details and help you make decisions that reduce the\ntax burden of your equity compensation.\n\n### 83(b) Elections\n\nThis section covers one of the most important and complex decisions you may need to make\nregarding stock awards and stock options:\npaying taxes early with an 83(b) election.\n\n- Generally, restricted stock is taxed as ordinary income\n  [*when it vests*](http://www.investopedia.com/articles/tax/09/restricted-stock-tax.asp?performancelayout=true).\n- If the stock is in a startup with low value, this may not result in high tax.\n  If it’s been years since the stock was first granted and the company is now worth a lot,\n  the taxes owed could be quite significant.\n\n🄳 The Internal Revenue Code, in\n[Section 83(b)](https://www.law.cornell.edu/uscode/text/26/83), offers taxpayers receiving\nequity in exchange for work the option to pay taxes on their options before they vest.\nIf qualified, a person can tell the IRS they prefer this alternative in a process called\nan\n[**83(b) election**](http://acceleratedvesting.com/what-is-an-83b-election-and-when-do-i-make-it-part-1-with-graphic/).\nPaying taxes early with an 83(b) election can potentially reduce taxes significantly.\nIf the shares go up in value, the taxes owed at vesting might be far greater than the\ntaxes owed at the time of receipt.\n\n- ☝️ Why is it called an *election*? Because you are *electing* (choosing) to pay taxes\n  early in exchange for this treatment by the IRS. Does the IRS secretly enjoy making simple\n  concepts sound confusing?\n  We’re not sure.\n- An 83(b) election isn’t guaranteed to reduce your taxes, however.\n  For example, the value of the stock may not increase.\n  And if you leave the company before you vest, you *don’t* get back the taxes you’ve\n  already paid.\n- ❗ You must file the 83(b) election yourself with the IRS\n  [**within 30 days**](https://www.irs.gov/irb/2012-28_IRB/ar12.html) of the grant or exercise, or\n  the opportunity is irrevocably lost.\n- ☝️ Note an 83(b) election is made on receipt of actual shares of stock.\n  Technically, it cannot be made on the receipt of a stock *option* itself:\n  You first must exercise that option, then file the election.\n- If you receive an early exercisable stock option (when you don’t have to wait for the the\n  stock to vest), you can make an 83(b) election upon receipt of the exercised shares.\n- Section 83(b) elections do not apply to vested shares;\n  the election only applies to stock that is not yet vested.\n  Thus, if you receive options that are *not* early exercisable (meaning you have to wait\n  until they vest to exercise), an 83(b) election would not apply.\n- 🔹 Founders and very early employees will almost always want to do an 83(b) election upon\n  the receipt of unvested shares, since the stock value is probably low.\n  If the value is really low, and the taxes owed are not that great, you can make the\n  election without having to pay much tax and start your capital gains holding period on the\n  shares.\n- 🚧 Clarify here which types of equity compensation the 83b can apply to.\n\n📰 With the passage of the\n[Tax Cuts and Jobs Act](https://en.wikipedia.org/wiki/Tax_Cuts_and_Jobs_Act_of_2017) (TCJA) in\n2017, Congress approved a\n[**new Section 83(i)**](https://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/wsgralert-section-83i.htm)\nthat is intended to allow deferral of tax until RSU and stock option holders can sell\nshares to pay the tax bill.\nWhether companies will choose or be able to make this available to employees is\n[not clear](http://stockoptioncounsel.com/blog/tax-deferred-option-exercises-under-the-new-section-83i-tax-cuts-and-jobs-act-of-2017)\nyet.\n\n### 409A Valuations\n\nWhen a person’s stock vests, or they exercise an option, the IRS determines the tax that\nperson owes. But if no one is buying and selling stock, as is the case in most startups,\nthen the value of the stock—and thus any tax owed on it—is not obvious.\n\n🄳 The **fair market value (FMV)** of any good or property refers to a price upon which the\nbuyer and seller have agreed, when both parties are willing, knowledgeable, and not under\ndirect pressure to carry out the exchange.\nThe fair market value of a company’s stock refers to the price at which a company will\nissue stock to its employees, and is used by the IRS to calculate how much tax an employee\nowes on any equity compensation they receive.\nThe FMV of a company’s stock is determined by the company’s most recent 409A valuation.\n\n🄳 A\n[**409A valuation**](http://www.fenwick.com/FenwickDocuments/409_Valuations_Stock_Options.pdf) is\nan assessment private companies are required by the IRS to conduct regarding the value of\nany equity the company issues or offers to employees.\nA company wants the 409A to be low, so that employees make more off options, but n","project_url":"https://awesome.ecosyste.ms/api/v1/projects/github.com%2Fjlevy%2Fog-equity-compensation","html_url":"https://awesome.ecosyste.ms/projects/github.com%2Fjlevy%2Fog-equity-compensation","lists_url":"https://awesome.ecosyste.ms/api/v1/projects/github.com%2Fjlevy%2Fog-equity-compensation/lists"}