Startup Equity Guide: From Offer to Exit

Last updated: Dec 3, 2025

Table of Contents

1. Introduction

For many developers joining startups, equity is a major component of the compensation package—a “lottery ticket” that could potentially be worth millions. However, startup equity is notoriously complex, opaque, and risky. Without a clear understanding of how it works, you might end up with a significant tax bill for stock that is ultimately worthless, or walk away from a life-changing payout due to a misunderstanding of terms.

This guide demystifies the lifecycle of startup equity, from the initial offer letter to the eventual exit (or lack thereof). Whether you’re evaluating a new job offer or deciding whether to exercise your vested options, this article provides the foundational knowledge you need to make informed financial decisions.

2. Types of Equity: Options vs. RSUs

Not all equity is created equal. The type of equity you receive depends largely on the stage of the company.

Stock Options (ISOs and NSOs)

Stock options give you the right to buy a specific number of shares at a fixed price (the “strike price”) within a certain timeframe. You don’t own the shares until you “exercise” your options by paying the strike price.

  • Incentive Stock Options (ISOs): Typically granted to employees. They offer potential tax advantages but come with strict rules and holding periods.

  • Non-Qualified Stock Options (NSOs): Often granted to contractors, advisors, or employees when ISO limits are reached. They are taxed more simply but usually at higher ordinary income rates upon exercise.

Restricted Stock Units (RSUs)

RSUs are a promise to give you shares outright after you meet certain conditions (usually vesting based on time). Unlike options, you don’t have to pay to acquire the shares. RSUs are typically used by later-stage private companies and public companies. When they vest, they are taxed immediately as ordinary income.

3. Understanding Your Offer

When you receive an equity offer, focus on these key terms:

  • Number of Shares/Options: The raw number (e.g., “10,000 options”). This number is meaningless without knowing the total outstanding shares.

  • Percentage of Ownership: The crucial metric. 10,000 shares out of 10 million (0.1%) is very different from 10,000 shares out of 100 million (0.01%). always ask for the percentage.

  • Strike Price (Exercise Price): The price you must pay to buy each share. Ideally, this is low.

  • Vesting Schedule: The timeline over which you earn the equity. The standard is a “4-year vest with a 1-year cliff.” This means you get nothing for the first year, then 25% of the total grant at the 1-year mark, followed by monthly vesting for the remaining 3 years.

4. To Exercise or Not to Exercise?

Exercising options means paying cash to buy the shares. This is a high-stakes decision because you are investing your own money into an illiquid, risky asset.

Reasons to Exercise Early (Pre-IPO):

  • To start the clock for long-term capital gains tax treatment (lower tax rates).

  • To minimize Alternative Minimum Tax (AMT) impact if the spread between strike price and fair market value (FMV) is small.

  • “Early Exercise” (if allowed): Exercising before vesting to file an 83(b) election, potentially paying zero taxes on future gains.

Reasons to Wait:

  • Risk: The company could fail, making your shares worthless. You lose the money you paid to exercise.

  • Liquidity: Your money is tied up until an exit event (IPO or acquisition), which could be years away or never happen.

5. Taxation of Equity

Taxation is complex and depends on the equity type and when you sell.

ISOs

  • At Grant: No tax.

  • At Exercise: No immediate regular tax, BUT the “spread” (FMV - Strike Price) is included in AMT calculations. This can trigger a large tax bill even if you haven’t sold the stock.

  • At Sale: If you hold for 1+ year after exercise AND 2+ years after grant, gains are taxed at lower long-term capital gains rates. Otherwise, it’s a “disqualifying disposition” taxed as ordinary income.

NSOs

  • At Exercise: The spread (FMV - Strike Price) is taxed as ordinary income (like salary). You owe income tax and payroll taxes immediately.

  • At Sale: Any further gain is capital gains.

RSUs

  • At Vesting: Taxed as ordinary income based on the current value. Companies often sell a portion of your shares automatically to cover the withholding taxes.

6. Exit Scenarios

How do you actually make money?

  • IPO (Initial Public Offering): The company lists on a stock exchange. You can sell your shares on the open market (usually after a 6-month “lock-up” period).

  • Acquisition: Another company buys your startup.

    • Cash Deal: You get cash for your vested shares (and potentially unvested ones, depending on the deal).

    • Stock Deal: Your shares are converted into shares of the acquiring company.

  • Secondary Markets: Occasionally, companies allow employees to sell shares to private investors before an exit (tender offers).

Liquidation Preferences

Investors (VCs) often have “liquidation preferences,” meaning they get paid back first before common shareholders (employees). In a “downside” exit (acquisition for less than the valuation), investors might take all the money, leaving employees with nothing, even if they have vested equity.

7. Dilution and Funding Rounds

As a company raises more money (Series A, B, C…), they issue new shares, which decreases your percentage of ownership (“dilution”). However, if the company’s value increases, the value of your smaller slice should ideally go up. Bad dilution happens during “down rounds” where the company raises money at a lower valuation than before.

8. Questions to Ask Before Accepting

Don’t be afraid to ask these questions to the recruiter or hiring manager:

What is the current number of fully diluted outstanding shares?
What is the most recent 409A valuation (Fair Market Value) per share?
What is the strike price for these options?
Is early exercise allowed?
What is the post-termination exercise period (PTEP)? (Standard is 90 days, but some companies offer 10 years).
Has the company undergone any down rounds or recapitalizations?

9. Conclusion

Startup equity can be a powerful wealth-building tool, but it requires active management and understanding. Treat your equity like a serious investment portfolio. Do the math, understand the tax implications (and consult a CPA!), and evaluate the company’s growth prospects critically. Don’t let the “lottery ticket” mentality blind you to the risks and mechanics of how you actually get paid.

Additional Resources

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