Don't give your team the wrong equity

Equity is one of the most powerful tools a startup has to attract and reward people. It is also one of the most confusing. Founders and early employees get hit with a wall of jargon — RSA, RSU, ESOP, 409A, FMV, 83(b), QSBS, ISO, NSO, double-trigger — and most of it is never explained clearly. The result is that critical decisions get made on autopilot, and people sometimes lose huge amounts of money because they ticked the wrong box at the wrong stage.

This article is an attempt to untangle all of it. It is written for both founders designing an equity plan and employees evaluating an offer. We will cover the most popular equity instruments, when each one makes sense, and how the math changes as a company grows. We will focus on US companies from incorporation through Series B — past that the rules change again.

📚 Terms you need to know

409A (also called FMV) 📊 — an independent valuation of the company's shares, required by the IRS. Rule of thumb: FMV is about 20–35% of the company's most recent round valuation. A 409A is considered expired when any of these happen:

you raise a new round
12 months have passed since the last one
something material happens (big revenue jump, major customer, term sheet in hand, M&A talks)

Once it expires you need a fresh one before granting any more options. Typical cost: $2K–$5K for an early-stage company (more for later-stage), turnaround 2–4 weeks. Providers like Carta, Pulley, or AngelList handle it routinely.

Vesting — equity is not given all at once. The standard is 4 years with a 1-year cliff: you get nothing if you leave in year one, then 25% lands at the 1-year mark, and the rest accrues monthly.

83(b) election — an IRS form. Normally you pay tax on equity as it vests, on whatever it is worth at the time. Filing 83(b) within 30 days of grant lets you pay tax now on the full grant instead of later. At a brand-new company where the equity is worth almost nothing, this is essentially free. At a later stage, it can be a big check. Only available for actual stock (RSA or early-exercised options), not RSUs.

Capital gains and QSBS — if you own actual stock and hold it for more than 1 year, gains are taxed as long-term capital gains: 0%, 15%, or 20% federal. If you hold it for more than 5 years in a qualifying company (under $50M in assets when you got the shares), it qualifies for QSBS: up to $10M of gain or 10x your basis is federal-tax-free. This is the single biggest tax advantage in startup equity. Crucially, you only get it if you own real stock — not RSUs.

Ordinary income — what you pay on a regular salary. Federal goes up to 37%, plus payroll taxes and state. This is what hits you on RSU settlements and on the spread when you exercise NSOs.

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Heads up: this is all US-centric. 83(b), 409A, QSBS, ISO/NSO treatment — all of it applies only to people taxed as US persons: US citizens (anywhere in the world), green card holders, and anyone who meets the IRS substantial presence test (broadly: physically in the US for ~183 days in a rolling window).

For employees working from overseas, the tax picture can be completely different — their home country may tax equity at grant, at vest, or at exercise depending on local rules, and US elections like 83(b) often don't help them. Sometimes RSUs are actually the cleaner choice abroad simply because settlement is a single, well-defined taxable event the company can withhold against.

If you're granting equity to someone outside the US, get specialized tax advice for their country before you do.

🎁 The three most popular equity instruments

RSA (Restricted Stock Award) 📜 — actual shares given to you on day one, subject to vesting. If you leave before vesting completes, the company buys back the unvested portion. You own real stock from the start.

ESOP (stock options) 🎯 — the right to buy shares later at a fixed strike price set today. The strike is almost always set to the current FMV (per the 409A) — companies can't set it lower without serious tax penalties, and there's no reason to set it higher. You don't own anything until you pay to exercise your options and convert them into actual shares. Most early plans use ISOs (incentive stock options) for the better tax treatment.

RSU (Restricted Stock Unit) 📝 — a promise that you will receive shares in the future. Private-company RSUs almost always require two triggers: time-vesting and an exit (IPO or acquisition) within some window, usually 7–10 years. Until both happen, you have nothing. When it does happen, the full value is taxed as ordinary income.

👩‍💻 Story 1: Jane joins a brand-new company

Jane is the founding engineer at a company that was incorporated two months ago. No funding, no revenue, no 409A. The founder offers her 2%, which is on the low end of normal for a founding engineer at this stage (1–3% is the standard range).

Shares are worth essentially nothing right now — par value, fractions of a cent. Let's walk through her three options.

Option A — RSA

Jane is granted 2% as actual shares. She files 83(b) within 30 days, paying tax on the full grant at today's value, which is effectively zero. From this moment she owns real stock, and the QSBS clock starts ticking.

She leaves after 3 years in good faith with 75% vested. She walks away owning that 75% outright, with essentially no money out of pocket. If the company later sells for $1B and her stake is worth $15M, the entire gain may be federal-tax-free thanks to QSBS.

Option B — ESOP (ISOs)

Jane is granted 2% in ESOPs, subject to the standard 4-year vesting. Since the shares are worth almost nothing right now, the strike price is also almost nothing. The smart move is to *early-exercise — that is, exercise the options right away, before they vest. The shares she gets come subject to the same vesting (the company can buy them back if she leaves early), but the QSBS clock starts immediately. At this stage there is no real cost and no downside. The moment she exercises and files 83(b), she owns real stock, and from that point on it is economically identical to the RSA*. Same QSBS clock, same long-term capital gains treatment.

If she does not exercise early and just lets the options vest: after 3 years she has 90 days to exercise the vested portion. Still cheap, still painless. But she has now lost two years of QSBS clock.

Option C — RSU

Jane is granted 2% in RSUs. After 3 years she has time-vested 75%, but no exit has happened. She leaves holding an IOU for those shares, conditional on the company exiting before her RSUs expire (typically 10 years from grant).

If the company exits in year 8 at $1B, her 75% becomes worth $15M — but the full $15M is taxed as ordinary income at the highest brackets. No QSBS. If the company never exits in time, she gets nothing.

Verdict

At this stage, RSA and early-exercised ISOs are essentially the same thing and both are excellent. RSUs are strictly worse — no QSBS, ordinary income on the upside, and a real risk of expiring worthless.

👨‍💼 Story 2: Josh joins at Series A

Three years later the company raises a Series A at $100M valuation. The 409A now puts the shares at roughly 25% of that, so $25M. Josh joins as a senior engineer and is offered 0.5%, which is around $125K of stock at the current FMV.

Option A — RSA

To take RSAs Josh would have to pay FMV for the shares: $125,000 in cash, up front, and file 83(b) within 30 days to lock in the basis. Most engineers can't or won't write that check. Even if Josh could afford it, he'd be putting $125K of his own money into a single illiquid stock. Not realistic at this stage.

Option B — ESOP (ISOs)

Josh gets options to buy 0.5% at a $2.50 strike (FMV at the time of his grant). No upfront cost.

After 2 years he leaves with 50% vested. He has 90 days to exercise or lose them. Cost to exercise: about $62,500 cash. On top of that, if the FMV has since climbed, there's a paper gain (called the "spread") that can trigger Alternative Minimum Tax — an additional bill on income he hasn't actually received.

So Josh's choice is: write a check for $60K+ to keep options that might still go to zero, or walk away with nothing. Many people walk. Most who exercise are uncomfortable doing it.

Option C — RSU

Josh gets 0.5% in RSUs with a 10-year expiration. He leaves after 2 years time-vested on 50%, no exit yet. No check to write, no 90-day deadline, no AMT. He simply waits.

If the company exits within 10 years of his grant, those shares pay out as ordinary income. If it doesn't, he gets nothing — but he never risked any of his own money.

Verdict

RSA is impractical. ESOPs force an ugly binary choice when leaving. RSUs are imperfect (ordinary income, no QSBS, expiration risk) but they are the only option that doesn't require Josh to gamble his savings or walk away empty-handed.

⚖️ Comparison

Rows are phrased so that ✅ = good outcome for the employee.

Property	RSA	ESOP	RSU
No cash needed at grant	✅ (only when FMV is ~$0)	✅	✅
No tax while company is private	✅ (with 83(b))	✅ (until exercise)	✅ (until exit)
Starts QSBS clock	✅ at grant	✅ at exercise	❌
Long-term capital gains on upside	✅	✅ (held 1y after exercise)	❌ — ordinary income
No forced check when leaving	✅	❌ (90-day deadline)	✅
Survives if company never exits	✅	✅ (once exercised)	❌ (expires)
Voting / dividend rights	✅	Only after exercise	❌
Works at near-zero FMV	✅	✅	❌
Works at high FMV	❌	⚠️	✅

📈 When does the math flip?

As the company grows, two things happen at once: typical grants shrink as a percentage of the company, and the cash needed to convert options into actual stock grows fast. The point where exercise cost gets bigger than an employee can comfortably write a check for is roughly where RSUs start to make sense.

Stage	Round valuation	FMV	Typical grant	Cost to exercise at year 4
Pre-funding	$0	~$0	2.5%	~$25
Seed	$20M	$5M	1.5%	~$75,000
Series A	$100M	$25M	0.5%	~$125,000
Series B	$400M	$100M	0.25%	~$250,000

The bars show typical founding-engineer grant size (%) at each stage. The line shows the cash needed to exercise the full vested grant after 4 years. By Series A you're looking at $100K+; by Series B, often $250K+. Series A or seed stage (depending on the size) is the inflection point for most employees.

Assumes 10M fully-diluted shares and FMV at roughly 25% of round valuation. AMT on the ISO spread can add meaningfully on top at Series A and later.

🎯 Recommendation matrix

Stage	RSA	ESOP	RSU
Pre-funding (FMV ~$0)	✅	✅	❌
Seed (FMV under $5M)	✅ (with early exercise)	✅	❌
Series A (FMV $5–50M)	❌	⚠️ (extend exercise window)	✅
Series B (FMV $50M+)	❌	⚠️	✅

💡 Conclusion

Use RSAs or ESOPs while the company is worth almost nothing. Both let employees capture QSBS and long-term capital gains, which is by far the best tax outcome on a successful exit. Once the 409A is large enough that exercise costs become a barrier — typically around Series A — switch to RSUs with a 10-year expiration window.

The most underrated alternative: keep using ESOPs, but extend the post-termination exercise window from the standard 90 days to 7–10 years. This solves the "leave and lose your options" problem without giving up QSBS or capital gains treatment. Pinterest, Coinbase, and others have done this. It is worth considering before defaulting to RSUs.

If you want to offer employees a choice between ISOs and RSUs at the same stage, that is possible but requires real tax guidance — most people can't navigate the decision alone and will default to whatever sounds simpler, which is usually not what's best for them.

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