Equity compensation can be worth more than your salary—or worth nothing. Understanding how it works is essential if you have it.
Types of Equity Compensation
Stock Options (ISOs and NSOs)
The right to buy stock at a set price (strike price) in the future.
| Type | Tax Treatment |
|---|---|
| ISO (Incentive Stock Options) | Better tax treatment, more rules |
| NSO (Non-Qualified Stock Options) | Taxed as income when exercised |
Value = Current price - Strike price
If strike price is $10 and stock is $50, each option is worth $40.
RSUs (Restricted Stock Units)
Promise to give you shares after vesting.
- No exercise required
- Taxed as ordinary income when they vest
- Value = Current stock price × number of shares
ESPP (Employee Stock Purchase Plan)
Buy company stock at a discount (usually 15%) through payroll deductions.
- Often a "guaranteed" 15%+ return
- Sell immediately for the safest strategy
Vesting Schedules
Most equity vests over time:
Common schedules:
- 4-year with 1-year cliff (25% after year 1, then monthly)
- 3-year with no cliff (monthly or quarterly)
- Backloaded (more in later years)
Stock Options: The Basics
Scenario:
- You have 10,000 options
- Strike price: $10
- Current stock price: $50
- Options are vested and exercisable
Value = (50 - 10) × 10,000 = $400,000
But you need cash to exercise:
- Exercise cost: $10 × 10,000 = $100,000
You pay $100k to get stock worth $500k.
Stock Options: Exercise Strategies
Exercise and Hold
- Pay exercise cost
- Hold the shares
- Hope for more appreciation
- Tax complexity (especially ISOs and AMT)
Exercise and Sell (Same Day)
- Exercise options
- Immediately sell shares
- Pocket the difference
- Simpler taxes
Cashless Exercise
Brokerage fronts the exercise cost, you sell enough to cover it.
RSUs: Simpler But Not Simple
When RSUs vest:
- Shares are deposited in your account
- Taxes are withheld (usually sell-to-cover)
- You own the remaining shares
Example:
- 1,000 RSUs vest
- Stock price: $100
- Value: $100,000
- Tax (40%): $40,000
- Shares sold to cover: 400
- Shares you keep: 600
The $100,000 is added to your income for the year.
ESPP: Often the Best Deal
Typical ESPP:
- 15% discount on stock
- Lookback provision (use lower of start or end price)
- Buy at end of offering period
Example with lookback:
- Start price: $100
- End price: $120
- You buy at: $100 × 0.85 = $85
- Immediate value: $120
- Instant return: 41%
The Concentration Problem
Your job AND your wealth are tied to one company. If the company fails, you lose both.
Strategy: Regularly sell equity and diversify into . Pay the taxes; protect your wealth.