Equity compensation is paying people with an ownership stake in the company, through stock options, restricted stock, or restricted stock units, instead of or alongside cash.

Founders care because equity compensation is how a cash-poor startup attracts talent it could not otherwise afford, and how it aligns a team around the same exit. The instrument you pick drives the tax result and the dilution.

The main forms of equity compensation

Stock options give the right to buy shares later at a fixed strike price. They come in two flavors. An incentive stock option can qualify for capital gains treatment under IRC Section 422 but only goes to employees. A non-qualified stock option can go to anyone and is taxed as ordinary income on the spread at exercise under IRC Section 83.

Restricted stock is actual stock issued now, subject to a vesting schedule and a company repurchase right on unvested shares. Founders usually receive restricted stock at formation when the price is near zero.

Restricted stock units, or RSUs, are a promise to deliver shares once conditions are met. RSUs are common at later-stage and public companies and generally tax as ordinary income when they settle. Early-stage startups more often use options and restricted stock.

Tax and pricing basics for equity compensation

Two rules shape almost every early grant. First, options must carry a strike price at least equal to fair market value, which is why the company gets a 409A valuation. Second, anyone buying stock subject to vesting should consider an 83(b) election under IRC Section 83(b), filed within 30 days, to be taxed on today’s low value rather than future vested value.

Here is a simple example. A startup hires an early engineer and grants options for 50,000 shares at a $0.20 strike, drawn from the employee option pool, vesting over four years. The engineer buys in over time at $0.20 and captures the upside above that price, while the company preserves cash.

Design choices compound. The instrument sets the tax path, the strike depends on the 409A number, and the size of the pool drives dilution across the cap table. Founders should decide these together, not one grant at a time.

This is general information, not tax advice.