Stock options vs. RSUs: What startup founders need to know

A stock option is a contract that gives an employee the right to purchase a specific number of company shares at a predetermined price, called the exercise or strike price. This right typically becomes available after a vesting period, often four years with a one-year cliff. The key word here is “right” rather than obligation. Employees can choose whether and when to exercise their options.

How stock options work

Employees exercise options by paying the strike price to convert their options into actual shares. If your company's share price rises above the strike price, the option holder can buy stock at that below-market strike price and potentially sell for a profit. Until exercised, stock options remain just the right to buy stock, not actual ownership. If the stock price never exceeds the strike price, the options may expire worthless and the employee gains nothing.

Types of stock options

There are two main types of stock options. Incentive stock options (ISOs) are available only to employees and can qualify for favorable tax treatment if specific holding requirements are met. When handled correctly, ISOs can result in profits being taxed at long-term capital gains rates rather than ordinary income rates. Non-qualified stock options (NSOs) can be granted to employees, advisors, and contractors. They're simpler to administer but less tax-efficient. At exercise, the spread between strike price and market value gets taxed as ordinary income.

How stock option vesting works

Most startups use a four-year vesting schedule with a one-year cliff. This means employees earn their options gradually over four years, with the first 25% vesting after one full year of service. Stock options create powerful motivation because they only have value if the company's value grows. If you have options to buy at $5 per share and the company later goes public at $50, exercising yields a $45 per share gain. But if the company stays flat or declines, those options might never be worth exercising. This structure aligns employees' financial interests directly with company performance.

RSUs are a promise from your company to grant a certain number of shares to an employee once specific conditions are met. These conditions typically involve time-based vesting, though some companies add performance milestones. Unlike options, RSUs require no purchase from the employee. When an RSU vests, it converts directly into actual shares that the employee owns outright. There's no strike price to pay.

How RSUs work

When RSUs vest, the promised shares appear in the employee's brokerage account. At that moment, the value of those shares becomes taxable income. For instance, if 100 RSUs vest when your stock trades at $20 per share, the employee receives 100 shares worth $2,000 total. That $2,000 counts as taxable income in that year, just like your salary or a bonus would.

After vesting, the employee can hold onto the shares or sell them if a market exists. Any change in stock price after vesting creates a capital gain or loss when those shares are eventually sold. The simplicity appeals to many employees who want straightforward compensation without the complexity of exercise decisions.

How vesting works with RSUs

RSUs commonly vest over time, often using the same four-year schedule as options. But private startups frequently add a twist called double-trigger vesting. This means RSUs require both time-based service and a liquidity event like an IPO or acquisition before shares are delivered. Startups use double triggers to avoid giving employees illiquid private stock along with a tax bill they can't pay by selling shares.

Public companies typically use single-trigger RSUs that vest based on time alone since employees can sell shares immediately to cover taxes. This difference in vesting structure is one of the key considerations when deciding between options and RSUs for your startup.

The value of RSUs

RSUs offer more certainty than options. Because there's no upfront cost and the shares always have some value at vesting, RSUs provide a guaranteed outcome as long as your company stock has any value. However, they can feel more like a predictable bonus than a lottery ticket. The upside is essentially the stock price at vesting plus any later appreciation, which may seem modest compared to the potential multi-fold gains from stock options in a rocket ship scenario.

When ownership happens

Stock options

With options, employees don't own stock until they exercise. Even after vesting, they only have the right to buy shares at the strike price. Many employees wait to exercise until an exit approaches or their options near expiration to avoid spending cash or triggering taxes too early. Until they exercise, the company retains those shares and the employee's stake exists only on paper. No voting rights, no dividends, and no actual ownership until money changes hands.

RSUs

RSUs create automatic ownership at vesting. The shares transfer to the employee without any action or payment required. RSU recipients immediately get voting rights and dividends on their vested shares, just like any other shareholder. This automatic conversion removes the guesswork and financial planning that comes with deciding when to exercise options.

Financial upside and risk

Stock options

Options offer potentially massive upside with corresponding risk. If your stock price soars from $1 to $100, an employee with a $1 strike price makes $99 per share. This lottery-ticket potential attracts risk-tolerant employees to startups. But if the stock price stays below the strike price, options become worthless paper. Employees might pay to exercise and then watch the stock decline, losing real money.

Timing matters tremendously with options. Employees must decide when to exercise based on their prediction of future stock movement, their personal financial situation, and tax considerations. They also face a ticking clock if they leave the company. Most startups give departing employees just 90 days to exercise vested options or lose them forever. This creates genuine risk of walking away with nothing after years of work.

RSUs

RSUs provide certainty at the cost of capped upside. When RSUs vest at $20 per share, the employee gets $20 of value per share, period. Even if the stock later drops to $10, they still received something tangible at vesting. The downside risk of ending up with zero is essentially eliminated as long as your company has any value at all.

The tradeoff is clear. An RSU worth $20 at vesting is worth $20, while an option with a $1 strike price would be worth $19 in the same scenario. But the option holder had to risk cash to exercise and could have ended up with nothing if the stock stayed below $1. RSUs work like a salary bonus tied to stock price, while options work like a leveraged bet on your company's growth.

Tax implications

Stock options

Granting stock options creates no immediate tax burden. Employees aren't taxed when options are granted or while they vest since they haven't received anything of value yet. Taxes kick in at exercise and sale.

For NSOs, the spread between market price and strike price at exercise gets taxed as ordinary income. If you exercise options with a $5 strike when the stock is worth $25, you owe ordinary income tax on that $20 spread per share. Any additional gain from holding the stock and selling later gets taxed as capital gains.

ISOs can qualify for better tax treatment if you hold the shares long enough. Meet the IRS holding requirements and your entire gain might qualify for long-term capital gains rates. But watch out for Alternative Minimum Tax (AMT) in the year you exercise ISOs, especially if the spread is large. Tax rules are complex and individual circumstances vary significantly, so employees should consult tax professionals before making exercise decisions.

RSUs

RSUs trigger taxes at vesting, not at grant. The entire value of vested shares counts as ordinary income in the vesting year. If your RSUs vest into shares worth $10,000, that $10,000 gets added to your W-2 income. Companies typically withhold taxes by keeping back some shares. At a 30% withholding rate, the company might retain $3,000 worth of shares for taxes, delivering the remaining $7,000 worth to the employee.

After vesting, any additional gain or loss from holding the shares gets capital gains treatment when sold. If those $10,000 worth of shares grow to $15,000 before sale, the $5,000 gain gets taxed as either short-term or long-term capital gains, depending on the holding period. The tax treatment becomes identical to any other stock investment after the initial vesting event.

Dilution and equity “burn”

Stock options

Stock options create an interesting math problem. When you grant options, you're creating the right for new shares to be issued in the future. This dilutes existing ownership once exercised. But here's the catch. You typically need to grant more options than you'd think to deliver a target compensation value. Why? Because the eventual payoff is uncertain. Some options expire worthless if your stock price doesn't rise above the strike price.

A startup might grant an employee 10,000 stock options at a low strike price to deliver what seems like good value at the time. Those options only become shares if exercised, so they eventually contribute to dilution just like RSUs. The difference is efficiency. Options require more equity “burn” upfront to provide equivalent value to an employee. You're essentially over-allocating to account for the risk that some value might never materialize.

RSUs

RSUs represent actual shares delivered upon vesting. Each unit has a clear current value equal to your share price. This means you can grant fewer RSUs to achieve the same compensation value you might target with a larger number of options. Less dilution for existing owners.

RSUs are more equity-efficient. They require less of your share pool to provide similar value to employees. Because each RSU is worth the full value of a share, you don't need to inflate the grant size to account for uncertainty. The value is already there. Once RSUs vest and convert to shares, they increase shares outstanding just like exercised options. But RSUs let you deliver the same reward with fewer shares, which becomes particularly valuable as your stock price grows higher and more stable.

When to switch

Stock options

In the early stages of a startup, stock options are the default choice for good reasons. Your valuation is low, so the strike price on options is low. This makes the upside potential attractive for employees if your company grows. You can conserve cash by offering options instead of high salaries, giving employees a stake in future growth.

Employees at this stage often accept options despite their risk because the potential payoff is enormous relative to the initial cost. If your startup's value multiplies, those cheap options could be life-changing. Options align employees with the high-risk, high-reward nature of your venture. They make sense when your fair market value is low and significant growth is anticipated. Employees can get a large number of options cheaply.

Using options early also avoids administrative hurdles that RSUs would impose on a private company. Stock options give employees flexibility on when to exercise and realize income, which can be beneficial tax-wise for those joining a promising startup. In your first several years, stock options help attract talent by offering substantial upside when your stock price is low and volatile.

RSUs

As companies mature, there's typically a shift toward RSUs. Data suggests companies switch from stock options to RSUs about 5.5 years after incorporation, around the time they reach roughly $1 billion in valuation. At this stage, your stock price is higher and more predictable. Offering guaranteed shares through RSUs is a safer, more tangible promise to employees.

Each RSU is a real piece of your company at its current valuation. Senior or risk-averse employees often prefer this over the uncertainty of options. As your valuation climbs, stock options become less attractive. A high strike price means less built-in upside. RSUs carry value regardless of short-term stock fluctuations and don't risk going underwater like options do when the stock falls below the strike price.

Late-stage companies have more resources to handle the tax withholding and administrative requirements that come with RSUs. By this point, you likely have a finance and HR team experienced enough to administer RSU programs and enough cash to cover withholding obligations. Many high-profile tech firms transition to RSUs in the run-up to going public. Airbnb switched from stock options to RSUs ahead of its IPO, standardizing its equity grants for a public-market mindset. However, this introduced challenges. Employees with pre-IPO RSUs had limited opportunities for liquidity before the IPO, leading to frustration among some who felt locked into waiting.

Accounting impact

Stock options

The accounting treatment for stock options spreads the expense over time. Under ASC 718, when you grant stock options, you must estimate their fair value at grant using a Black-Scholes model. That value gets recognized as an expense over the vesting period. Each quarter, a portion of the option's fair value hits your books, reflecting the service period employees work to earn the options.

This straight-line recognition creates a relatively smooth expense pattern in your financial statements. The cost gets booked even if the options are never exercised, since it's based on grant-date fair value and service. If an option grant is valued at $100,000 total and vests over four years, you might recognize about $25,000 of expense per year for four years, adjusted for any forfeitures if employees leave early.

This method has been standard since accounting rules changed in the mid-2000s, requiring companies to expense stock options similar to other compensation. The predictable, steady impact on reported earnings makes financial planning more straightforward.

RSUs

RSUs can create a big one-time expense under certain conditions. If you issue simple time-based RSUs as a public company, the accounting is straightforward. The fair value equals the stock price at grant, and that expense is recognized over the vesting period, similar to options.

But many private companies issue RSUs with a double-trigger structure. These require both time-based vesting and a liquidity event like an IPO. In these cases, you accrue the expense during the vesting period but don't officially recognize it in earnings until the second trigger happens. When the IPO or sale occurs, all that accumulated expense hits your income statement at once. This can dramatically skew your financial results in that period.

While stock option costs trickle onto the books steadily, RSUs with performance conditions lead to delayed expense that appears all at once when the condition is met. Adopting RSUs, especially with an IPO on the horizon, might make your GAAP financials look less profitable in the period when those RSUs vest. It's largely an accounting timing issue. The economic value is being delivered either way, but it can impact reported earnings and optics. In a public company setting without double-triggers, RSU expense would be recognized evenly over the vesting term, much like options.

Administrative complexity

Stock options

Stock options come with established but ongoing administrative requirements. The biggest is obtaining a regular 409A valuation of your common stock. Because options must have an exercise price at or above fair market value to avoid immediate tax issues for employees, you need a 409A appraisal at least every 12 months and whenever a material event occurs, like a new funding round. This ensures the strike price on new grants is considered fair market value by the IRS.

Beyond valuations, stock option plans require managing grant agreements and educating employees on what their options actually mean. You must maintain cap table records showing how many options each person has, their vesting schedules, and what happens when people leave. Most option plans give departing employees a limited window, often 90 days, to exercise vested options.

Administering exercises adds another layer. When an employee decides to exercise, you must collect the exercise price payment, issue share certificates or update electronic ownership records, and ensure compliance with any blackout periods or company policies. Each exercise is a mini-transaction that your stock administration or legal team needs to process. There's also the employee education component. Early employees might not understand the tax implications of exercising options, like potential Alternative Minimum Tax for incentive stock options or the benefits of exercising early to start the capital gains clock. While this isn't paperwork administration, companies relying on options often spend significant effort communicating these nuances so equity is valued and utilized properly.

RSUs

RSUs simplify some things but complicate others, especially for private companies. On the simpler side, RSUs have no strike price and no voluntary exercise transactions. Employees don't pay anything out of pocket or decide when to exercise. You simply deliver shares once RSUs vest and any conditions are met. This makes RSUs straightforward for employees. There's no risk of expiring unexercised and no action required to realize the shares.

For private companies using RSUs, complexity arises primarily from the double-trigger structure and tax handling. Companies impose a performance condition like an IPO on RSUs to avoid employees owing taxes on shares they can't sell. This defers taxes effectively, but it means tracking an additional vesting condition for potentially hundreds of employees over multiple years. All those RSUs remain in limbo on your cap table until the liquidity event happens.

When that IPO or acquisition finally occurs, all those RSUs vest at once. You face a major administrative and financial task. At the moment RSUs vest and convert to shares, the value is considered wage income to employees. You're obligated to withhold taxes just like on a bonus or salary. Typically, you'll automatically withhold a portion of the vesting shares to cover tax, often at 22% for federal income tax and 37% on amounts over $1M. For a large late-stage startup IPO, this could mean coordinating tens or hundreds of millions of dollars in tax withholdings.

Finance and HR teams must prepare well in advance. You need to ensure all employees sign necessary agreements for double-trigger RSUs, monitor timelines given IRS limits on RSU deferral periods, and prepare to communicate and assist employees through the tax hit at IPO. If you switch to RSUs too early while remaining private for years, you might find yourself constrained. Running private tender offers or secondary liquidity events is harder with RSUs since they aren't actual shares yet to sell.

When to use stock options

Early-stage startups

Stock options make the most sense when your company has minimal value and maximum growth potential ahead. At incorporation or seed stage, you can offer options with strike prices of pennies per share. This creates massive upside potential for early employees who believe in your vision. A software engineer joining at a $10 million valuation might see 100x returns if you reach unicorn status.

Cash preservation matters too. Options cost your company nothing upfront and don't require immediate tax withholding. This matters when managing startup costs carefully since every dollar saved on compensation expenses can be redirected toward product development, customer acquisition, or other essential startup costs. This also helps extend your startup runway while still offering competitive total compensation packages. Early employees who join for below-market salaries often accept this tradeoff specifically because they want exposure to exponential upside through options.

High-growth scenarios

Options shine when you expect hockey stick growth. They give employees leveraged exposure to your company's success without requiring them to invest significant capital upfront. This asymmetric risk-reward profile attracts the kind of ambitious, risk-tolerant talent that thrives in startup environments.

The psychological impact shouldn't be underestimated. Options create an ownership mentality where employees think like investors. They celebrate customer wins, obsess over metrics, and push for ambitious goals because their personal wealth directly ties to company performance. This alignment becomes especially powerful when everyone holds options with low strike prices.

Attracting risk-tolerant talent

Options naturally filter for employees who believe in your mission and growth trajectory. People who demand guaranteed compensation probably aren't the right fit for an early-stage startup anyway. By leading with options, you attract candidates who want to build something significant rather than optimize for steady income.

This self-selection helps build the intense, committed culture that successful startups need. Your team members become true partners in the journey, sharing both the risks and potential rewards of building a company from scratch.

When to use RSUs

Later-stage companies

RSUs become attractive as your company matures and your valuation climbs. Once you've raised Series B or C funding at high valuations, the potential upside from new option grants diminishes. An engineer joining at a $1 billion valuation might see 2-3x returns if things go well, not the 100x possibility from earlier stages.

At this point, RSUs offer more predictable value that helps you compete with public company compensation packages. Candidates comparing your offer to Google or Facebook need to see real, quantifiable value, not just lottery tickets. RSUs provide that certainty while still offering equity participation.

Pre-IPO situations

Companies planning an IPO within 12-24 months often switch to RSUs. The double-trigger vesting structure solves a critical problem by delaying taxation until liquidity arrives. Employees avoid getting hit with massive tax bills on illiquid private stock while still accumulating equity value.

RSUs also simplify your equity story for prospective employees who might not understand option exercise mechanics. "You'll receive $200,000 worth of stock over four years" is easier to grasp than explaining strike prices, exercise windows, and AMT implications.

Retention-focused strategies

RSUs work better for retention because they guarantee value delivery. An employee with underwater options might leave since their equity has no value. But RSUs always provide something at vesting, creating a stronger incentive to stay through each vesting date.

This predictability helps with workforce planning and reduces the risk of mass departures during market downturns. Even if your stock price drops 50%, RSU holders still receive tangible value at each vesting event, just less than originally expected.

The choice between stock options and RSUs isn't just about financial mechanics. It's about the culture you want to build and the people you want to attract. Options create an ownership culture where everyone bets on massive success. RSUs provide stability and predictability that help you compete for experienced talent.

Most successful startups evolve their approach over time. They start with options when the company is young and risky, then gradually introduce RSUs as they mature and need different types of employees. The key is staying intentional about these decisions rather than defaulting to what everyone else does.

Your equity compensation strategy should align with your company's stage, growth trajectory, and talent needs. Get it right, and equity becomes a powerful tool for building the team that will make your startup successful. Get it wrong, and you'll struggle to attract talent or watch valuable employees leave for better packages elsewhere.

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