Stock Options and RSUs: A Developer's Guide to Equity Compensation

Last updated: Apr 14, 2025

Table of Contents

1. Introduction

For developers in the tech industry, equity compensation—stock options and restricted stock units (RSUs)—can represent a significant portion of total compensation. Understanding these instruments is crucial for making informed career decisions and maximizing financial outcomes. Whether you’re joining a startup offering options or a public tech giant granting RSUs, this guide will help you navigate the complexities of equity compensation.

Equity can be life-changing wealth or a worthless piece of paper, depending on the company’s success and your understanding of the terms. This article breaks down the key concepts, tax implications, and strategies you need to make smart decisions about your equity compensation.

2. Types of Equity Compensation

Tech companies typically offer two main types of equity compensation: stock options and restricted stock units. Understanding the differences is essential for evaluating offers.

2.1 Stock Options (ISO vs NSO)

Stock options give you the right to purchase company stock at a predetermined price (the “strike price” or “exercise price”) within a specific timeframe.

  • Incentive Stock Options (ISOs):Available to employees only, with potential tax advantages. Qualify for special tax treatment under IRS rules if certain conditions are met.

  • Non-Qualified Stock Options (NSOs):Available to employees, consultants, and advisors. No special tax treatment—taxed as ordinary income upon exercise.

Options typically have a 10-year expiration date and vest over 4 years (with a 1-year cliff). The “cliff” means you must stay with the company for at least one year to earn any options.

2.2 Restricted Stock Units (RSUs)

RSUs are company shares granted to you that vest over time. Unlike options, you don’t need to purchase them—you receive the shares outright upon vesting (after paying applicable taxes).

  • Vesting:Typically 4 years with a 1-year cliff, similar to options.

  • Taxation:Taxed as ordinary income when they vest, based on the fair market value at vesting time.

  • Liquidity:RSUs in public companies can be sold immediately upon vesting (subject to trading windows). In private companies, liquidity depends on a future exit event.

2.3 Comparing Equity Types

Feature
Stock Options
RSUs

Upfront Cost
Exercise price to purchase
No purchase required

Potential Upside
Unlimited (if stock price rises)
Direct share appreciation

Downside Risk
Can expire worthless
Always has some value (if company has value)

Tax Complexity
High (AMT, timing decisions)
Lower (taxed at vesting)

Best For
High-growth startups
Established public companies

3. Key Concepts and Terminology

Understanding these terms will help you navigate equity conversations and documentation.

3.1 Vesting Schedules

Vesting determines when you actually own the equity. Most tech companies use a 4-year vesting schedule with a 1-year cliff:

  • 1-year cliff:No equity vests until you’ve been with the company for one year. After the cliff, you receive 25% of the total grant.

  • Monthly/quarterly vesting:After the cliff, equity typically vests monthly or quarterly over the remaining 3 years.

  • Acceleration clauses:Some agreements include single-trigger (acquisition) or double-trigger (acquisition + termination) acceleration that vests additional equity upon certain events.

3.2 Exercise Price and Fair Market Value

For stock options, the exercise price (strike price) is set at the fair market value (FMV) of the stock at the time of grant. This price determines your potential profit:

// Example calculation
const strikePrice = 10.00;  // per share
const currentFMV = 50.00;   // per share
const shares = 10000;
const potentialProfit = (currentFMV - strikePrice) * shares;  // $400,000

The spread (difference between FMV and exercise price) is what you stand to gain. For RSUs, there’s no exercise price—you receive the full value of the shares at vesting.

3.3 Liquidity Events

Equity only becomes cash when a liquidity event occurs:

  • IPO (Initial Public Offering):Company goes public, shares can be traded on stock exchanges.

  • Acquisition:Company is bought by another company, often for cash or stock.

  • Secondary Sales:Private companies may allow employees to sell shares to approved investors before an IPO.

  • Tender Offers:Company buys back shares from employees.

Understanding the company’s timeline to liquidity is crucial for evaluating equity value.

4. Tax Implications

Tax treatment varies significantly between ISOs, NSOs, and RSUs. Proper planning can save you thousands of dollars.

4.1 Tax Treatment of Stock Options

ISOs: No regular income tax upon exercise (but may trigger Alternative Minimum Tax). If you hold shares for at least 2 years from grant and 1 year from exercise, profit qualifies as long-term capital gains (lower tax rate).

NSOs: Taxed as ordinary income on the spread at exercise. Subsequent appreciation taxed as capital gains when sold.

4.2 Tax Treatment of RSUs

RSUs are taxed as ordinary income when they vest, based on the fair market value at vesting. Companies typically withhold shares to cover taxes (called “sell-to-cover”). The remaining shares are yours to keep or sell.

4.3 Alternative Minimum Tax (AMT)

The AMT is a parallel tax system that can affect ISO exercises. When you exercise ISOs (but don’t sell), the spread is considered a “preference item” for AMT calculations, potentially creating a large tax bill even without selling any shares. This is one of the most common pitfalls for startup employees.

Consult a tax professional before exercising large ISO grants to understand AMT implications.

5. Negotiation and Evaluation

Evaluating and negotiating equity requires a different approach than salary negotiation.

5.1 Evaluating Equity Offers

When comparing offers with equity components:

Determine current valuation: Ask for the company’s latest 409A valuation (FMV per share) and preferred share price (if different).
Calculate potential value: Multiply shares by current FMV (for RSUs) or by estimated exit value minus strike price (for options).
Assess dilution: Understand the fully diluted share count to know what percentage of the company your grant represents.
Consider risk: Startup equity is high-risk; public company RSUs are lower-risk but with less upside potential.

5.2 Negotiation Tips for Developers

  • Negotiate the number of shares, not percentage:Companies think in shares, not percentages.

  • Ask about refresh grants:Many companies provide additional equity grants annually (“refresh grants”) to retain talent.

  • Consider the entire package:Balance salary, bonus, benefits, and equity based on your risk tolerance and financial needs.

  • Get everything in writing:Ensure the equity grant details are documented in your offer letter and follow-up grant agreement.

Remember that equity is worthless until a liquidity event. Don’t sacrifice too much salary for uncertain equity unless you believe strongly in the company’s potential.

6. Conclusion

Equity compensation can be a powerful wealth-building tool for developers, but it comes with complexity and risk. Understanding the differences between stock options and RSUs, along with their tax implications, is essential for making informed decisions.

Key takeaways:

  • ISOs offer tax advantagesbut come with AMT risk and require careful timing.

  • RSUs are simplerand lower-risk but offer less upside potential.

  • Always consider the company’s stageand path to liquidity when evaluating equity.

  • Consult professionalsfor tax planning and legal review of equity agreements.

Whether you’re joining an early-stage startup or a tech giant, approaching equity compensation with knowledge and strategy will help you maximize your financial outcomes throughout your career.

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