The Holloway Guide to Equity Compensation

Stock options, RSUs, job offers, and taxes—a detailed reference, including hundreds of resources, explained from the ground up and made to be improved over time.
80 pages (4 hours read time) and 362 links — last update 2 months ago

edition

Credits

Original Authors

  • Joshua Levy (Holloway)
  • Joe Wallin (Carney Bradley Spellman)

Contributions and Review

  • José Ancer (Egan Nelson LLP)
  • Michael Brown (Fenwick & West)
  • George Grellas (Grellas Shah LLP)
  • Zach Holman
  • Chris McCann (Greylock Partners)
  • Leo Polovets (Susa Ventures)
  • Eric Tyson

Production

  • Rachel JepsenEditor
  • Andy SparksEditor
  • Hope HackettResearch
  • Dmitriy Kharchenko & Leigh TaylorGraphics
With the help of many other contributors

Introduction13 minutes, 5 links

Equity compensation is the practice of granting partial ownership in a company in exchange for work. In its ideal form, equity compensation aligns the interests of individual employees with the goals of the company they work for, which can yield dramatic results in team building, innovation, and longevity of employment. Each of these contributes to the creation of value—for a company, for its users and customers, and for the individuals who work to make it a success.

The ways equity can be granted as compensation—including restricted stock, stock options, and restricted stock units—are notoriously complex. Equity compensation involves confounding terminology, legal obscurities, and many high-stakes decisions for those who give and receive it.

If you talk to enough employees and hiring managers, you’ll hear stories of how they or their colleagues met with the painful consequences of not learning enough up front. Though many people learn the basic ideas from personal experience or from colleagues or helpful friends who have been through it before, the intricacies of equity compensation are best understood by tax attorneys, corporate lawyers, and other professionals.

Understanding the technicalities of equity compensation does not guarantee that fortune will smile upon you as warmly as it did the early hires of Facebook. But a thorough overview can help you be informed when discussing with professionals for further assistance, make better decisions for your personal situation, and avoid some common and costly mistakes.

Why this Guide?

The first edition of this work, written by the same lead authors as the one you’re reading now, received significant feedback and discussion on Hacker News, on GitHub, and from individual experts. Now, Holloway is pleased to publish this new edition of the Guide. We’ve expanded sections, added resources and visuals, and filled in gaps.

There is a lot of information about equity compensation spread across blogs and articles that focus on specific components of the topic, such as vesting, types of stock options, or equity levels. We believe there is a need for a consolidated and shared resource, written by and for people on different sides of compensation decisions, including employees, hiring managers, founders, and students. Anyone can feel overwhelmed by the complex details and high-stakes personal choices that this topic involves. This reference exists to answer the needs of beginners and the more experienced.

Holloway and our contributors are motivated by a single purpose: To help readers understand important details and their contexts well enough to make better decisions themselves. The Guide aims to be practical (with concrete suggestions and pitfalls to avoid), thoughtful (with context and multiple expert perspectives, including divergent opinion on controversial topics), and concise (it is dense but contains only notable details—still, it’s at least a three-hour read, with links to three hundred sources!).

The Guide does not purport to be either perfect or complete. A reference like this is always in process. That’s why we’re currently testing features to enable the Holloway community to suggest improvements, contribute new sections, and call out anything that needs revision. We welcome (and will gladly credit) your help.

We especially wish to recognize the dozens of people who have helped write, review, edit, and improve it so far—and in the future—and hope you’ll check back often as it improves.

Scope

This Guide currently covers:

Topics not yet covered:

  • Equity compensation programs, such as ESPPs in public companies. (We’d like to see this improve in the future.)
  • Full details on executive equity compensation.
  • Compensation outside the United States.
  • Compensation in companies other than C corporations, including LLCs and S corporations, where equity compensation is approached and practiced in very different ways.

For these situations, see other resources and get professional advice.

Who may find this useful

Our aim is to be as helpful to the beginner as to those with more experience. Having talked with employees, CEOs, investors, and lawyers, we can assure you that no matter how much you know about equity compensation, you will likely run into confusion at some point.

If you’re an employee or a candidate for a job, some of these may apply to you:

  • You’ve heard phrases like stock, stock options, strike price, ISOs, RSUs, 83(b) election, 409A valuation, AMT, or early exercise and know they are probably important but are mystified by what some of them really mean or whether they apply to your situation.
  • You’re considering a job offer but don’t know how to navigate or negotiate the equity component of the offer.
  • You’re joining a startup for the first time and are overwhelmed by all the paperwork.
  • You’re quitting, taking a leave of absence, or are being laid off or fired from a company where you have stock or options and are thinking through the decisions and consequences.
  • A company you work for is going through an acquisition, IPO, or shutdown.
  • You have stock in a private company and need cash.

Founders or hiring managers who need to talk about equity compensation with employees or potential hires will also find this Guide useful. As many entrepreneurs and hiring managers will tell you, this topic isn’t easy on that side of the table, either! Negotiating with candidates and fielding questions from candidates and employees requires understanding the same complex technicalities of equity compensation well.

That said, this topic is not simple and we ask that readers be willing to invest time to get through a lot of confusing detail. If you’re in a hurry, or you don’t care to learn the details, this Guide may not be for you. Seek advice.

A note on fairness

Much of what you read about equity compensation was written by a single person, from a single vantage point. The authors and editors of this Guide have navigated the territory of equity compensation from the perspective of employees, hiring managers, founders, and lawyers. We do believe that the knowledge here, combined with professional advice, can make a significant difference for both employees and hiring managers.

One of the difficulties for candidates negotiating equity compensation is that they may have less information about what they are worth than the person hiring them. Companies talk to many candidates and often have access to or pay for expensive market-rate compensation data. While some data on typical equity levels have been published online, much of it fails to represent the value of a candidate with their own specific experience in a specific role. However, even without exact data, candidates and hiring managers can develop better mental frameworks to think about offers and negotiations.

On the other hand, challenges are not limited to those of employees. Founders and hiring managers also often struggle with talking through the web of technicalities with potential hires, and can make equally poor decisions when making offers. Either over-compensating or under-compensating employees can have unfortunate consequences.

In short, both companies and employees are routinely hurt by uninformed decisions and costly mistakes when it comes to equity compensation. A shared resource is helpful for both sides.

Roadmap8 minutes, 2 links

The Holloway Reader

The Holloway Reader you’re using now is designed to help you find and navigate the material you need. Use the search box. It will reveal definitions, section-by-section results, and content contained in the hundreds of resources we’ve linked to throughout the Guide. Think of it as a mini library of the best content on equity compensation. We also provide mouseover (or short tap on mobile) for definitions of terms, related section suggestions, and external links while you read.

How this Guide is organized

This Guide contains a lot of material. And it’s dense. Some readers may wish to read front to back, but you can also search or navigate directly to parts that are of interest to you, referring back to foundational topics as needed.

Equity compensation lies at the intersection of corporate law, taxation, and employee compensation, and so requires some basic understanding of all three. You might think compensation and taxation are separate topics, but they are so intertwined it would be misleading to explain one without the other. We cover material in logical order, so that if you do read the earlier sections first, later sections on the interactions of tax and compensation will be clearer.

We start with Equity Compensation Basics: What compensation and equity are, and why equity is used as compensation.

But before we get much further, we need to talk about what stock is, and how companies are formed. Fundamentals of Stock Corporations covers how companies organize their ownership, how stock is issued, public companies and private companies, and IPOs and liquidity (which determine when equity is worth cash).

While not everyone reading this works at an early stage company, those who do can benefit from understanding the role of equity in Startups and Growth. This is good context for anyone involved in a private company that has taken on venture capital.

How Equity is Granted is the core of this Guide. We describe the forms in which equity is most commonly granted, including restricted stock grants, stock options, and RSUs.

Now is where it gets messier—taxes:

After these technical concerns, we move on to how you can think about all this in practice. These sections focus on scenarios common to employees and candidates, but are also of likely interest to founders and hiring managers:

  • Plans and Scenarios: Whether you have equity now or will in the future, it is helpful to learn how to think about the value of equity and its tax burden. We also cover whether you can sell private stock.
  • Offers and Negotiations: Equity often comes up as you’re negotiating or debating whether to accept a job offer. Here we cover what to expect, what to ask, tips and pitfalls, and more.

Finally, we offer some additional resources:

  • Documents and Agreements: A bit more detail on the actual legal paperwork you’re likely to see as you negotiate and after you’ve accepted an offer.
  • Further Reading: A curated list of what else you can read on the subject, including many papers, books, and articles that have informed this Guide.

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When to turn elsewhere

CEOs, CFOs, COOs, or anyone who runs a company or team of significant size should be sure to talk to an equity compensation consultant or a specialist at a law firm to learn about equity compensation plans.

Founders looking for an introduction to the legalities of running a company may wish to check out Legal Concepts for Founders, from Clerky, in addition to talking to a lawyer. Founders should also lean on their investors for advice, as they may have additional experience.

Executive compensation at large or public companies is an even more nuanced topic, on both sides of the table. Hire an experienced lawyer or compensation consultant. There are extensive legal resources available on executive compensation.

Seeking professional advice

This Guide does not replace professional advice.

Please read the full disclaimer and seek professional advice from a lawyer, tax professional, or other compensation expert before making significant decisions.

Does that make reading through these details a waste of time? Not at all. Important decisions rarely should or can be blindly delegated. This Guide complements but does not replace the advice you get from professionals. Working with the support of a professional can help you make better decisions when you have an understanding of the topic yourself and know what questions to ask.

Equity Compensation Basics10 minutes, 25 links

History and significance

Companies ranging from two-person startups to the Fortune 500 have found that granting partial ownership in a company is among the best methods to attract and retain exceptional talent. In the United States, partial ownership through stock options has been a key part of pay for executives and other employees since the 1950s. As recently as 2014, 7.2% of all private sector employees (8.5 million people) and 13.1% of all employees of companies with stock held stock options (from a NCEO analysis). Many believe employee ownership has fostered innovations in technology, especially in Silicon Valley, from the early days of Hewlett-Packard to recent examples like Facebook. Stock options helped the first 3,000 employees of Facebook enjoy roughly $23 billion at the time the company went public (Financial Times).

controversy Some controversy surrounds the use of equity compensation for high-paid executives. Public companies offer executives equity compensation in no small part because of a tax loophole. In 1993, President Bill Clinton attempted to limit executive pay with a new section of the Internal Revenue Code, 162(m). Unfortunately, the legislation backfired; a loophole made performance-based pay—including stock options—fully tax deductible, thereby creating a dramatic incentive to pay executives through stock options (Balsam). From 1970–79, the average compensation for a CEO of one of the 50 largest firms in the United States was $1.2M, of which 11.2% was from stock options. By 2000–05, the same numbers had risen to $9.2M and 37%, respectively (Frydman & Jenter, Fig. 2).

Growth and risk

Generally, equity compensation is closely linked to the growth of a company. Cash-poor startups persuade early employees to take pay cuts and join their team by offering meaningful ownerships stakes, catering to hopes that the company will one day grow large enough to go public or be sold for an ample sum. More mature but still fast-growing companies find offering compensation linked to ownership is more attractive than high cash compensation to many candidates.

With the hope for growth, however, also comes risk. Large, fast-growing companies often hit hard times. And startups routinely fail or yield no returns for investors or workers. According to a report by Cambridge Associates and Fortune Magazine, between 1990 and 2010, about 60% of venture capital-backed companies returned less than the original investment, leaving employees with the painful realization that their startup was not, in fact, the next Google. Of the remaining 40%, just a select few go on to make a many of their employees wealthy, as has been the case with iconic high-growth companies, like Starbucks, UPS, Amazon, Google, or Facebook.

Compensation and equity

Definition Compensation is any remuneration to a person (including employees, contractors, advisors, founders, and board members) for services performed or rendered to a company. Compensation comes in the forms of cash pay (salary and any bonuses) and any non-cash pay, including benefits like health insurance, family-related protections, perks, and retirement plans.

Company strategies for compensation are far from simple. Beth Scheer, head of talent at the venture fund Homebrew, offers a thoughtful overview of compensation in startups.

Another term you may encounter is total rewards, which refers to a model of attracting and retaining employees using a combination of salary and incentive compensation (like equity), benefits, recognition for contribution or commitment (like awards and bonuses), training programs, and initiatives to improve the work environment.

Definition In the context of compensation and investment, equity broadly refers to any kind of ownership in a company that can be held by individuals (like employees or board members) and by other businesses (like venture capital firms). One common kind of equity is stock, but equity can take other forms, such as stock options or warrants, that give ownership rights. Commonly, equity also comes with certain conditions, such as vesting or repurchase rights. Note the term equity also has several other technical meanings in accounting and real estate.

Definition Equity compensation is the practice of granting equity in exchange for work.

In this Guide we focus on equity compensation in stock corporations, the kind of company where ownership is represented by stock. (We describe stock in more detail in the next section.) Equity compensation in the form of a direct grant of stock with no strings attached is very rare. Instead, employees are given stock with additional restrictions placed on it, or are given contractual rights that later can lead to owning stock. These forms of equity compensation include restricted stock, stock options, and restricted stock units, each of which we’ll describe in detail.

The goals of equity compensation

The purpose of equity compensation is threefold:

  • Attract and retain talent: When a company already has or can be predicted to have significant financial success, talented people are incentivized to work for the company by the prospect of their equity being worth a lot of money in the future. The actual probability of life-changing lucre may be low (or at least, lower than you may think if your entire knowledge of startups is watching “The Social Network”). But even a small chance at winning big can be worth the risk to many people, and to some the risk itself can be exciting.
  • Align incentives: Even companies that can afford to pay lots of cash may prefer to give employees equity, so that employees work to increase the future value of the company. In this way, equity aligns individuals’ incentives with the interests of the company. At its best, this philosophy fosters an environment of teamwork and a “rising tides lift all boats” mentality. It also encourages everyone involved to think long-term, which is key for company success. As we’ll discuss later, the amount of equity you’re offered usually reflects both your contribution to the company and your commitment to the company in the future.
  • Reduce cash spending: By giving equity, a company can often pay less in cash compensation to employees now, with the hope of rewarding them later, and put that money toward other investments or operating expenses. This can be essential in the early stages of a company or at other times where there may not be enough revenue to pay large salaries. Equity compensation can also help recruit senior employees or executives who would otherwise command especially high salaries.

Fundamentals of Stock Corporations18 minutes, 36 links

In this section, we describe the basics of how stock and shares are used.

Those familiar with stock, stock corporations, public companies, and private companies can jump ahead to how those companies grant equity.

Kinds of companies

Definition A corporation is a company that is legally recognized as a single entity. The corporation itself, and not its owners, is obligated to repay debts and accountable under contracts and legal actions (that is, is a “legal person”). Most commonly, the term corporation is used to refer to a stock corporation (or joint-stock company), which is a corporation where ownership is managed using stock. Non-stock corporations that do not issue stock exist as well, the most common being nonprofit organizations. (A few less common for-profit non-stock corporations also exist.)

In practice, people often use the word company to mean corporation.

Definition A C corporation (or C corp) is a type of stock corporation in the United States with certain federal tax treatment. It is the most prevalent kind of corporation. Most large, well-known American companies are C corporations. C corporations differ from S corporations and other business entities in several ways, including how income is taxed and who may own stock. C corporations have no limit on the number of shareholders allowed to own part of the company. They also allow other corporations, as well as partnerships, trusts, and other businesses, to own stock.

In practice, for a few reasons, these companies are usually formed in Delaware, so legalities of all this are defined in Delaware law. You can think of Delaware law as the primary “language” of U.S. corporate law. Incorporating a company in Delaware has evolved into a national standard for high-growth companies, regardless of where they are physically located.

caution This Guide focuses specifically on C corporations and does not cover how equity compensation works in LLCs, S corporations, partnerships, or sole proprietorships. Both equity and compensation are handled in significantly different ways in each of these kinds of businesses.

Loosely, one way to think about companies is that they are simply a set of contracts, negotiated over time between the people who own and operate the company, and which are enforced by the government, that aligns the interests of everyone involved in creating things customers are willing to pay for. Key to these contracts is a way to precisely track ownership of the company; issuing stock is how companies often choose to do this.

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Stock and shares

Definition Stock ownership is often formalized on stock certificates, which are fancy pieces of paper that prove who owns the stock.

Sometimes you have stock but don’t have the physical certificate, as it may be held for you at a law office.

Some companies now manage their ownership through online services called ownership management platforms, such as Carta. If the company you work for uses an ownership management platform, you will be able to view your stock certificates and stock values online.

Younger companies may also choose to keep their stock uncertificated, which means your sole evidence of ownership is your contracts with the company, and your spot on the company’s cap table, without having a separate certificate for it.

Definition Outstanding shares refer to the total number of shares held by all shareholders. This number starts at an essentially arbitrary value (such as 10 million) when the company is created, and thereafter will increase as new shares are added (issued) and granted to people in exchange for money or services.

Outstanding shares may increase or decrease for other reasons too, such as stock splits and share buybacks, which we won’t get into here.

Later, we discuss several subtleties in how shares are counted.

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Definition Any shareholder has a percentage ownership in the company, determined by dividing the number of shares they own by the number of outstanding shares. Although stock paperwork will always list numbers of shares, if share value is uncertain, percentage ownership is often a more meaningful number, particularly if you know or can estimate a likely valuation of the company. Even if the number of shares a person has is fixed, their percentage ownership will change over time as the outstanding shares change. Typically, this number is presented in percent or basis points (hundredths of a percent).

Public and private companies

Definition Public companies are corporations in which any member of the public can own stock. People can buy and sell the stock for cash on public stock exchanges. The value of a company’s shares is the value displayed in the stock market reports, so shareholders know how much their stock is worth.

Definition Most smaller companies, including all startups, are private companies with owners who control how those companies operate. Unlike a public company, where anyone is able to buy and sell stock, owners of a private company control who is able to buy and sell stock. There may be few or no transactions, or they may not be publicly known.

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Governance

Definition A corporation has a board of directors, a group of people whose legal obligation is to oversee the company and ensure it serves the best interests of the shareholders. Public companies are legally obligated to have a board of directors, while private companies often elect to have one. The board typically consists of inside directors, such as the CEO, one or two founders, or executives employed by the company, and outside directors, who are not involved in the day-to-day workings of the company. These board members are elected individuals who have legal, corporate governance rights and duties when it comes to voting on key company decisions. A board member is said to have a board seat at the company.

Boards of directors range from 3 to 31 members, with an average size of 9. Boards are almost always an odd number in order to avoid tie votes. It’s worth noting that that state of California requires public companies to have at least one woman on their boards.

Key decisions of the board are made formally in board meetings or in writing (called written consent). Many decisions around granting equity to employees are approved by the board of directors.

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IPOs

Definition A private company becomes a public company in a process called an initial public offering (IPO). Historically, only private companies with a strong track record of years of growth have considered themselves ready to take this significant step. The IPO has pros and cons that include exchanging a host of high regulatory costs for the benefits of significant capital. After a company “IPOs” or “goes public," investors and the general public can buy stock, and existing shareholders can sell their stock far more easily than when the company was private.

Companies take years to IPO after being formed. The median time between a company’s founding and its IPO has been increasing. According to a Harvard report, companies that went public in 2016 took 7.7 years to do so, compared to 3.1 years for companies that went public in 1996.

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Sales and liquidity

danger️ With private companies, it can be very hard to know the value of equity. Because the value of private company stock is not determined by regular trades on public markets, shareholders can only make educated guesses about the likely future value, at a time when they will be able to sell stock.

After all, private company stock is simply a legal agreement that entitles you to something of highly uncertain value, and could well be worthless in the future, or highly valuable, depending on the fate of the company.

confusion We’ll discuss the notion of a company officially assigning a fair market value later, but even if a company gives you a value for your stock for tax and accounting purposes, it doesn’t mean you can expect to sell it for that value!

Definition An acquisition is the purchase of more than 50% of the shares of one company (the acquired company) by another company (the purchaser). This is also called a sale of the acquired company. In an acquisition, the acquired company cedes control to the purchaser.

Definition The ability to buy and sell stock is called liquidity. In startups and many private companies, it is often hard to sell stock until the company is sold or goes public, so there is little or no liquidity for shareholders until those events occur. Thus, sales and IPOs are called both exits and liquidity events. Sales, dissolutions, and bankruptcy are all called liquidations.

Often people wish they could sell stock in a private company, because they would prefer having the cash. This is only possible occasionally. We get into the details later, in our section on selling private stock.

Definition A dividend is a distribution of a company’s profit to shareholders, authorized by the board of directors. Established public companies and some private companies pay dividends, but this is rare among startups and companies focused on rapid growth, since they often wish to re-invest their profits into expanding the business, rather than paying that money back to shareholders. Amazon, for example, has never paid dividends.

Startups and Growth23 minutes, 43 links

If you’re considering working for a startup, what we cover next on how these early-stage companies raise money and grow is helpful in understanding what your equity may be worth.

If you’re only concerned with large and established companies, you can skip ahead to how equity is granted.

Startups

Definition A startup is an emerging company, typically a private company, that aspires to grow quickly in size, revenue, and influence. Once a company is established in the market and successful for a while, it usually stops being called a startup.

confusion Unlike the terminology around corporations, which has legal significance, the term startup is informal, and not everyone uses it consistently.

Startups are not the same as small businesses. Small businesses, like a coffee shop or plumbing business, typically intend to grow slowly and organically, while relying much less on investment capital and equity compensation. Distinguished startup investor Paul Graham has emphasized that it’s best to think of a startup as any early stage company intending to grow quickly.

technical C corporations dominate the startup ecosystem. LLCs tend to be better suited for slower-growth companies that intend to distribute profits instead of re-investing them for growth. Because of this, and for complex reasons related to how their capital is raised, venture capitalists significantly prefer to invest in C corporations.

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Fundraising, growth, and dilution

Many large and successful companies began as startups. In general, startups rely on investors to help fund rapid growth.

Definition Fundraising is the process of seeking capital to build or scale a business. Selling shares in a business to investors is one form of fundraising, as are loans and initial coin offerings. Financing refers both to fundraising from outside sources and to bringing in revenue from selling a product or service.

Definition Venture capital is a form of financing for early-stage companies that individual investors or investment firms provide in exchange for partial ownership, or equity, in a company. These investors are called venture capitalists (or VCs). Venture capitalists invest in companies they perceive to be capable of growing quickly and commanding significant market share. “Venture” refers to the risky nature of investing in early-stage businesses—typically startups—with unproven business models.

A startup goes through several stages of growth as it raises capital based on the hope and expectation that the company will grow and make more money in the future.

Definition Companies add (or “issue”) shares during fundraising, which can be exchanged for cash from investors. As the number of outstanding shares goes up, the percentage ownership of each shareholder goes down. This is called dilution.

confusion Dilution doesn’t necessarily mean that you’re losing anything as a shareholder. As a company issues stock and raises money, the smaller percentage of the company you do have could be worth more. The size of your slice gets relatively smaller, but, if the company is growing, the size of the cake gets bigger. For example, a typical startup might have three rounds of funding, with each round of funding issuing 20% more shares. At the end of the three rounds, there are more outstanding shares—roughly 73% more in this case, since 120%×120%×120% is 173%—and each shareholder owns proportionally less of the company.

Definition The valuation of the company is the present value investors believe the company has. If the company is doing well, growing revenue or showing indications of future revenue (like a growing number of users or traction in a promising market), the company’s valuation will usually be on the rise. That is, the price for an investor to buy one share of the company would be increasing.

danger️ Of course, things do not always go well, and the valuation of a company does not always go up. It can happen that a company fails entirely and all ownership stakes become worthless, or that the valuation is lower than expected and certain kinds of shares become worthless while other kinds have some value. When investors and leadership in a company expect the company to do better than it actually does, it can have a lot of disappointing consequences for shareholders.

Dilution illustrations

These visualizations illustrate how ownership of a venture-backed company evolves as funding is raised. One scenario imagines changes to ownership in a well-performing startup, and the other is loosely based on a careful analysis of Zipcar, a ride-sharing company that experienced substantial dilution before eventually going public and being acquired. These diagrams simplify complexities such as the ones discussed in that analysis, but they give a sense of how ownership can be diluted.

Loading chart…

Stages of a startup

Understanding the value of stock and equity in a startup requires a grasp of the stages of growth a startup goes through. These stages are largely reflected in how much funding has been raised—how much ownership, in the form of shares, has been sold for capital.

Very roughly, typical stages are:

  • Bootstrapped (little funding or self-funded): Founders are figuring out what to build, or they’re starting to build with their own time and resources.
  • Series Seed (roughly $250K to $2 million in funding): Figuring out the product and market. The low end of this spectrum is now often called pre-seed.
  • Series A ($2 to $15 million): Scaling the product and making the business model work.
  • Series B (tens of millions): Scaling the business.
  • Series C, D, E, etc. (tens to hundreds of millions): Continued scaling of the business.

Keep in mind that these numbers are more typical for startups located in California. The amount raised at various stages is typically smaller for companies located outside of Silicon Valley, where what would be called a seed round may be called a Series A in, say, Houston, Denver, or Columbus, where there are fewer companies competing for investment from fewer venture firms, and costs associated with growth (including providing livable salaries) are lower.

caution Most startups don’t get far. According to an analysis of angel investments, by Susa Ventures general partner Leo Polovets, more than half of investments fail; one in 3 are small successes (1X to 5X returns); one in 8 are big successes (5X to 30X); and one in 20 are huge successes (30X+).

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caution Each stage reflects the reduction of risk and increased dilution. For this reason, the amount of equity team members get is higher in the earlier stages (starting with founders) and increasingly lower as a company matures. (See the picture above.)

The option pool

Definition At some point early on, generally before the first employees are hired, a number of shares will be reserved for an employee option pool (or employee pool). The option pool is part of a legal structure called an equity incentive plan. A typical size for the option pool is 20% of the stock of the company, but, especially for earlier stage companies, the option pool can be 10%, 15%, or other sizes.

Once the pool is established, the company’s board of directors grants stock from the pool to employees as they join the company.

technical Well-advised companies will reserve in the option pool only what they expect to use over the next 12 months or so; otherwise, given how equity grants are usually promised, they may be over-granting equity. The whole pool may never be fully used, but companies should still try not to reserve more than they plan to use. The size of the pool is determined by complex factors between founders and investors. It’s worth employees (and founders) understanding that a small pool can be a good thing in that it reflects the company preserving ownership in negotiations with investors. The size of the pool may be increased later.

Counting shares

There are some key subtleties you’re likely to come across in the way outstanding shares are counted:

Definition Private companies always have what are referred to as authorized but unissued shares, referring to shares that are authorized in legal paperwork but have not actually been issued. Until they are issued, the unissued stock these shares represent doesn’t mean anything to the company or to shareholders: no one owns it.

confusion For example, a corporation might have 100 million authorized shares, but will only have issued 10 million shares. In this example, the corporation would have 90 million authorized but unissued shares. When you are trying to determine what percentage a number of shares represents, you do not make reference to the authorized but unissued shares.

confusion You actually want to know the total issued shares, but even this number can be confusing, as it can be computed more than one way. Typically, people count shares in two ways: issued and outstanding and fully diluted.

Definition Issued and outstanding refers to the number of shares actually issued by a company to shareholders, and does not include shares that others may have an option to purchase.

Definition Fully diluted refers to all of the shares that a company has issued, all of the shares that have been set aside in a stock incentive plan, and all of the shares that could be issued if all convertible securities (such as outstanding warrants) were exercised.

A key difference between fully diluted shares and shares issued and outstanding is that the total of fully diluted shares will include all the shares in the employee option pool that are reserved but not yet issued to employees.

important If you’re trying to figure out the likely percentage a number of shares will be worth in the future, it’s best to know the number of shares that are fully diluted.

technical Even the fully diluted number may not take into account outstanding convertible securities (like convertible notes) that are waiting to be converted into stock at a future milestone. For a more complete understanding, in addition to asking about the fully-diluted capitalization you can ask about any convertible securities outstanding that are not included in that number.

confusion The terminology mentioned here isn’t universally applied. It’s worth discussing these terms with your company to be sure you’re on the same page.

Definition A capitalization table (cap table) is a table (often a spreadsheet or other official record) that records the ownership stakes, including number and class of shares, of all shareholders in the company. It is updated as stock is granted to new shareholders.

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Classes of stock

Definition Investors often ask for rights to be paid back first in exchange for their investment. The way these different rights are handled is by creating different classes of stock. (These are also sometimes called classes of shares, though that term has another meaning in the context of mutual funds.)

Definition Two important classes of stock are common stock and preferred stock. In general, preferred stock has “rights, preferences, and privileges” that common stock does not have. Typically, investors get preferred stock, and founders and employees get common stock (or stock options).

The exact number of classes of stock and the differences between them can vary company to company, and, in a startup, these can vary at each round of funding.

confusion Another term you’re likely to hear is founders’ stock, which is (usually) common stock allocated at a company’s formation, but otherwise doesn’t have any different rights from other common stock.

Although preferred stock rights are too complex to cover fully, we can give a few key details:

Definition Preferred stock usually has a liquidation preference (or preference), meaning the preferred stock owners will be paid before the common stock owners when a liquidity event occurs, such as if the company is sold or goes public.

Definition A company is in liquidation overhang when the value of the company doesn’t reach the dollar amount investors put into it. Because of liquidation preference, those holding preferred stock (investors) will have to be paid before those holding common stock (employees). If investors have put millions of dollars into a company and it’s sold, employees’ equity won’t be worth anything if the company is in liquidation overhang and the sale doesn’t exceed that amount.

confusion The complexities of the liquidation preference are infamous. It’s worth understanding that investors and entrepreneurs negotiate a lot of the details around preferences, including:

  • The multiple, a number designating how many times the investor must be paid back before common shareholders receive proceeds. (Often the multiple is 1X, but it can be 2X or higher.)

  • Whether preferred stock is participating, meaning investors get their money back and also participate in proceeds from common stock.

  • Whether there is a cap, which limits the payout if it is participating.

  • technical This primer by Charles Yu gives a concise overview. Founders and companies are affected significantly and in subtle ways by these considerations. For example, as lawyer José Ancer points out, common and preferred stockholders are typically quite different and their incentives sometimes diverge.

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important For the purposes of an employee who holds common stock, the most important thing to understand about preferences is that they’re not likely to matter if a company does well in the long term. In that case, every stockholder has valuable stock they can eventually sell. But if a company fails or exits for less than investors had hoped, the preferred stockholders are generally first in line to be paid back. Depending on how favorable the terms are for the investor, if the company exits at a low or modest valuation, it’s likely that common shareholders will receive little—or nothing at all.

How Equity is Granted32 minutes, 35 links

In this section we’ll lay out how equity is granted in practice, including the differences, benefits, and drawbacks of common types of equity compensation, including restricted stock awards, stock options, and restricted stock units (RSUs). We’ll go over a few less common types as well. While the intent of each kind of equity grant is similar, they differ in many ways, particularly around how they are taxed.

Except in rare cases where it may be negotiable, the type of equity you get is up to the company you work for. In general, larger companies grant RSUs, and startups grant stock options, and occasionally executives and very early employees get restricted stock awards.

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Restricted stock awards

At face value, the most direct approach to equity compensation would be for the company to award stock to an employee in exchange for work. In practice, it turns out a company will only want to do this with restrictions on how and when the stock is fully owned.

Even so, this is actually one of the least common ways to get equity. We mention it first because it is the simplest form of equity compensation, useful for comparison as things get more complex.

Definition A restricted stock award is when a company grants someone stock as a form of compensation. The stock awarded has additional conditions on it, including a vesting schedule, so is called restricted stock. Restricted stock awards may also be called simply stock awards or stock grants.

technical What restricted means here is actually complex. It refers to the fact that the stock (i) has certain restrictions on it (like transfer restrictions) required for private company stock, and (ii) will be subject to repurchase at cost pursuant to a vesting schedule. The repurchase right lapses over the service-based vesting period, which is what is meant in this case by the stock “vesting.”

confusion Restricted stock awards are not the same thing as restricted stock units.

Typically, stock awards are limited to executives or very early hires, since once the value of the shares increases, the tax burden of receiving them (without paying the company for their value) can be too great for most people. Usually, instead of restricted stock, an employee will get stock options.

Stock options

Definition Stock options are contracts that allow individuals to buy a specified number of shares in the company they work for at a fixed price. Stock options are the most common way early-stage companies grant equity.

Definition A person who has received a stock option grant is not a shareholder until they exercise their option, which means purchasing some or all of their shares at the strike price. Prior to exercising, an option holder does not have voting rights.

Definition The strike price (or exercise price) is the fixed price per share at which stock can be purchased, as set in a stock option agreement. The strike price is generally set lower (often much lower) than what people expect will be the future value of the stock, which means selling the stock down the road could be profitable.

confusion Stock options is a confusing term. In investment, an option is a right (but not an obligation) to buy something at a certain price within a certain time frame. You’ll often see stock options discussed in the context of investment. What investors in financial markets call stock options are indeed options on stock, but they are not compensatory stock options awarded for services. In this Guide, and most likely in any conversation you have with an employer, anyone who says “stock options” will be referring to compensatory stock options.

confusion Stock options are not the same as stock; they are only the right to buy stock at a certain price and under a set of conditions specified in an employee’s stock option agreement. We’ll get into these conditions next.

technical Although everyone typically refers to “stock options” in the plural, when you receive a stock option grant, you are receiving an option to purchase a given number of shares. So technically, it’s incorrect to say someone “has 10,000 stock options.”

It’s best to understand the financial and tax implications before deciding when to exercise options. In order for the option to be tax-free to receive, the strike price must be the fair market value of the stock on the date the option is granted.

technical Those familiar with stock trading (or those with economics degrees) will tell you about the Black-Scholes model, a general mathematical model for determining the value of options. While theoretically sound, this does not have as much practical application in the context of employee stock options.

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Vesting and cliffs

Definition Vesting is the process of gaining full legal rights to something. In the context of compensation, founders, executives, and employees typically gain rights to their grant of equity incrementally over time, subject to restrictions. People may refer to their shares or stock options vesting, or may say that a person is vesting or has fully vested.

Definition In the majority of cases, vesting occurs incrementally over time, according to a vesting schedule. A person vests only while they work for the company. If the person quits or is terminated immediately, they get no equity, and if they stay for years, they’ll get most or all of it.

Awards of stock, stock options, and RSUs are almost always subject to a vesting schedule.

Definition Vesting schedules can have a cliff designating a length of time that a person must work before they vest at all.

For example, if your equity award had a one-year cliff and you only worked for the company for 11 months, you would not get anything, since you haven’t vested in any part of your award. Similarly, if the company is sold within a year of your arrival, depending on what your paperwork says, you may receive nothing on the sale of the company.

A very common vesting schedule is vesting over 4 years, with a 1 year cliff. This means you get 0% vesting for the first 12 months, 25% vesting at the 12th month, and 1/48th (2.08%) more vesting each month until the 48th month. If you leave just before a year is up, you get nothing, but if you leave after 3 years, you get 75%.

Definition In some cases, vesting may be triggered by specific events outside of the vesting schedule, according to contractual terms called accelerated vesting (or acceleration). Two kinds of accelerated vesting that are commonly negotiated are if the company is sold or undergoes a merger (single trigger) or if it’s sold and the person is fired (double trigger).

controversy Cliffs are an important topic. When they work well, cliffs are an effective and reasonably fair system to both employees and companies. But they can be abused and their complexity can lead to misunderstandings:

  • The intention of a cliff is to make sure new hires are committed to staying with the company for a significant period of time. However, the flip side of vesting with cliffs is that if an employee is leaving—quits or is laid off or fired—just short of their cliff, they may walk away with no stock ownership at all, sometimes through no fault of their own, as in the event of a family emergency or illness. In situations where companies fire or lay off employees just before a cliff, it can easily lead to hard feelings and even lawsuits (especially if the company is doing well enough that the stock is worth a lot of money).
  • important As a manager or founder, if an employee is performing poorly or may have to be laid off, it’s both thoughtful and wise to let them know what’s going on well before their cliff.
  • technical Founders often have vesting on their stock themselves. As entrepreneur Dan Shapiro explains, this is often for good reason.
  • important As an employee, if you’re leaving or considering leaving a company before your vesting cliff is met, consider waiting. Or, if your value to the company is high enough, you might negotiate to get some of your stock “vested up” early. Your manager may well agree that is is fair for someone who has added a lot of value to the company to own stock even if they leave earlier than expected, especially for something like a family emergency. These kinds of vesting accelerations are entirely discretionary, however, unless you negotiated for special acceleration in an employment agreement. Such special acceleration rights are typically reserved for executives who negotiate their employment offers heavily.
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  • Acceleration when a company is sold (called change of control terms) is common for founders and not so common for employees. It’s worth understanding acceleration and triggers in case they show up in your option agreement, but these may not be something you can negotiate unless you are going to be in a key role.
  • Companies may impose additional restrictions on stock that is vested. For example, your shares are very likely subject to a right of first refusal, which means that you can’t sell the stock without offering it first to the company. And it can happen that companies reserve the right to repurchase vested shares in certain events.

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How options expire

Definition The exercise window (or exercise period) is the period during which a person can buy shares at the strike price. Options are only exercisable for a fixed period of time, until they expire, typically seven to ten years as long as the person is working for the company. But this window is not always open.

danger Expiration after termination: Options can expire after you quit working for the company. Often, the expiration is 90 days after termination of service, making the options effectively worthless if you cannot exercise before that point. As we’ll get into later, you need to understand the costs, taxes, and tax liabilities of exercise and to plan ahead. In fact, you can find out when you are granted the options, or better yet, before you sign an offer letter.

important Longer exercise windows: Recently (since around 2015) a few companies are finding ways to keep the exercise window open for years after leaving a company, promoting this practice as fairer to employees. Companies with extended exercise windows include Amplitude, Clef, Coinbase, Pinterest, and Quora. However, the 90-day exercise window remains the norm.

controversy The exercise window debate: Whether to have extended exercise windows has been debated at significant length. Some believe extended exercise windows are the future, arguing that a shorter window makes a company’s success a punishment to early employees.

Key considerations include:

  • Everyone agrees that employees holding stock options with an expiring window often have to make a painful choice if they wish to leave: Pay for a substantial tax bill (perhaps five to seven figures) on top of the cost to exercise (possibly looking for secondary liquidity or a loan) or walk away from the options.
  • Many familiar with this situation have spoken out forcefully against shorter exercise windows, arguing that an employee can help grow the value of a company substantially—often having taken a lower salary in exchange for equity—but end up with no ownership because they’re unable or unwilling to stay for the several years typically needed before an IPO or sale.
  • On the other side, a few companies and investors stand by the existing system, arguing that it is better to incentivize people not to leave a company, or that long windows effectively transfer wealth from employees who commit long-term to those who leave.
  • Some focused on the legalities also argue that it’s a legal requirement of ISOs to have a 90-day exercise window. While this is technically true, it’s not the whole story. It is possible for companies to extend the exercise window by changing the nature of the options (converting them from ISOs to NSOs) and many companies now choose to do just that.
  • Another path is to split the difference and give extended windows only to longer-term employees.
  • Taken together, it’s evident many employees have not been clear on the nuances of this when joining companies, and some have suffered because of it. With the risks of short exercise windows for employees becoming more widely known, longer exercise windows are gradually becoming more prevalent. As an employee or a founder, it is fairer and wiser to understand and negotiate these things up front, and avoid unfortunate surprises.

A note on advisors: Options granted to advisors typically vest over a shorter period than employee grants, often one to two years. Advisor grants also typically have a longer exercise window post termination of service, and will usually have single trigger acceleration on an acquisition, because no one expects advisors to stay on with a company once it’s acquired. Typical terms for advisors, including equity levels, are available in the Founder/Advisor Standard Template (FAST), from the Founder Institute.

Kinds of stock options

Definition Compensatory stock options come in two flavors, incentive stock options (ISOs) and non-qualifying stock options (NQOs, or NQSOs). Confusingly, lawyers and the IRS use several names for these two kinds of stock options, including statutory stock options and non-statutory stock options (or NSOs), respectively.

In this Guide, we refer to ISOs and NSOs.

TypeAlso called
StatutoryIncentive stock option, ISO
Non-statutoryNon-qualifying stock option, NQO, NQSO, NSO
  • Companies generally decide to give ISOs or NSOs depending on the legal advice they get. It’s rarely up to the employee which they will receive, so it’s best to know about both. There are pros and cons of each from both the recipient’s and the company’s perspective.
  • ISOs are common for employees because they have the possibility of being more favorable from a tax point of view than NSOs.
  • caution ISOs can only be granted to employees (not independent contractors or directors who are not also employees).
  • But ISOs have a number of limitations and conditions and can also create difficult tax consequences.

Early exercise

Definition Sometimes, to help reduce the tax burden on stock options, a company will make it possible for option holders to early exercise (or forward exercise) their options, which means they can exercise even before they vest. The option holder becomes a stockholder sooner, after which the vesting applies to actual stock rather than options. This will have tax implications.

caution However, the company has the right to repurchase the unvested shares, at the price paid or at the fair market value of the shares (whichever is lower), if a person quits working for the company. The company will typically repurchase the unvested shares should the person leave the company before the stock they’ve purchased vests.

Restricted stock units

While stock options are the most common form of equity compensation in smaller private companies, RSUs have become the most common type of equity award for public and large private companies. Facebook pioneered the use of RSUs as a private company to allow it to avoid having to register as a public company earlier.

Definition Restricted stock units (RSUs) refer to an agreement by a company to issue an employee shares of stock or the cash value of shares of stock on a future date. Each unit represents one share of stock or the cash value of one share of stock that the employee will receive in the future. (They’re called units since they are neither stock nor stock options, but another thing altogether that is contractually linked to the value of stock.)

Definition The date on which an employee receives the shares or cash payment for RSUs is known as the settlement date.

  • caution RSUs may vest according to a vesting schedule. The settlement date may be the time-based vesting date or a later date based on, for instance, the date of a company’s IPO.
  • RSUs are difficult in a startup or early stage company because when the RSUs vest, the value of the shares might be significant, and taxes will be owed on the receipt of the shares. This is not a bad result when the company has sufficient capital to help the employee make the tax payments, or the company is a public company that has put in place a program for selling shares to pay the taxes. But for cash-strapped private startups, neither of these are possibilities. This is the reason most startups use stock options rather than RSUs or stock awards.
  • RSUs are often considered less preferable to grantees since they remove control over when you owe tax. Options, if granted with an exercise price equal to the fair market value of the stock, are not taxed until exercise, an event under the control of the optionee. If an employee is awarded an RSU or restricted stock award which vests over time, they will be taxed on the vesting schedule; they have been put on “autopilot” with respect to the timing of the tax event. If the shares are worth a lot on the date of vesting, the tax burden can be significant.
  • confusion You don’t want to confuse restricted stock units with restricted stock, which typically refers to restricted stock awards.

Less common types of equity

While most employee equity compensation takes the form of stock, stock options, or RSUs, a complete tour of equity compensation must mention a few less common forms.

Definition Phantom equity is a type of compensation award that references equity, but does not entitle the recipient to actual ownership in a company. These awards come under a variety of different monikers, but the key to understanding them is knowing that they are really just cash bonus plans, where the cash amounts are determined by reference to a company’s stock. Phantom equity can have significant value, but may be perceived as less valuable by workers because of the contractual nature of the promises. Phantom equity plans can be set up as purely discretionary bonus plans, which is less attractive than owning a piece of something.

Two examples of phantom equity are phantom stock and stock appreciation rights:

Definition A phantom stock award is a type of phantom equity that entitles the recipient to a payment equal to the value of a share of the company’s stock, upon the occurrence of certain events.

Definition Stock appreciation rights (SARs) are a type of phantom equity that gives the recipient the right to receive a payment calculated by reference to the appreciation in the equity of the company.

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Definition Warrants are another kind of option to purchase stock, generally used in investment transactions (for example, in a convertible note offering, investors may also get a warrant, or a law firm may ask for one in exchange for vendor financing). They differ from stock options in that they are more abbreviated and stand-alone legal documents, not granted pursuant to a single legal agreement (typically called a “plan”) for all employees.

Employees and advisors may not encounter warrants, but it’s worth knowing they exist.

Tax Basics16 minutes, 45 links

The awarding of equity compensation can give rise to multiple types of taxes for the recipient, including federal and state income taxes and employment taxes. There’s a lot that you have to be aware of. Skip ahead to understand how taxes on equity work, but if you have time, this section gives a technical summary of tax fundamentals, just in case you never really figured out all the numbers on your pay stub.

You don’t need to know every detail, and can rely on software and professionals to determine the tax you owe, but we do suggest understanding the different kinds of taxes, how large they can be, and how each is “triggered” by different events.

Given the complexity, most taxpayers aren’t aware of exactly how their tax is calculated. It does take up thousands of pages of the federal tax code and involves the intricate diversity of state tax law as well.

confusion If you’re already familiar with tax terminology, this section may not have any major surprises. But for those who are not used to it, watch out: Many terms sound like regular English, but they’re not. Ordinary income, long-term and short-term, election, qualified small business, and other phrases have very specific meanings we’ll do our best to spell out.

Kinds of income

Definition Income is the money an individual makes. For tax purposes, there are two main types of income, which are taxed differently. Ordinary income includes wages, salary, bonuses and interest made on investments. Capital gains are the profits an individual makes from selling assets, including stock.

One key difference between ordinary income and capital gains is that when capital gains taxes are calculated, consideration is given not just to the sale price of the asset but to the total gain or loss the investment incurred, each outcome having significantly different tax consequences.

Definition Capital gains are classified as long-term or short-term. Long-term capital gains are the profits an individual makes from selling assets, such as stock, a business, a house, or land, that were held for more than a year. Short-term capital gains are profits from the sale of assets held for less than a year.

Although this topic is not without controversy, the general idea is, if you are selling something you’ve owned for a long time, you can be taxed a lower rate.

All these rates have evolved over time based on economic and political factors, so you can be confident they will change again in the future.

new In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), which made many changes to tax rates for the 2018 tax year. Long-term capital gains taxes did not change significantly.

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Federal taxes

Definition Income tax is the money paid by individuals to federal, state, and, in some cases, local governments, and includes taxation of ordinary income and capital gains. Generally, U.S. citizens, residents, and some foreigners must file and pay federal income tax.

important In general, federal tax applies to many kinds of income. If you’re an employee at a startup, you need to consider four kinds of federal tax, each of which is computed differently.

confusion When it comes to equity compensation, it’s possible that you’ll have to worry about all of these, depending on your situation. That’s why we have a lot to cover here:

Definition Ordinary income tax is the tax on wages or salary income, and short-term investment income. The term short-term capital gains tax may be applied to taxes on assets sold less than a year from purchase, but profits from these sales are taxed as ordinary income. For a lot of people who make most of their money by working, ordinary income tax is the biggest chunk of tax they pay.

Definition Employment taxes are an additional kind of federal tax beyond ordinary income tax, and consist of Social Security and Medicare taxes that are withheld from a person’s paycheck. Employment taxes are also referred to as payroll taxes as they often show up on employee pay stubs. The Social Security wage withholding rate in 2018 is 6.2% up to the FICA wage base. The Medicare component is 1.45%, and it does not phase out above the FICA wage base.

Definition Long-term capital gains tax is a tax on the sale of assets held longer than a year. Long-term capital gains tax is often lower than ordinary income tax. Many investors hold assets for longer than a year in order to qualify for the lesser tax burden of long-term capital gains.

Definition Alternative minimum tax (AMT) is a supplemental income tax that applies to certain individuals in some situations. This type of tax does not come up for many taxpayers, but higher income earners and people in special situations may have to pay large AMT bills. AMT was first enacted in 1979 in response to reports that 155 wealthy individuals had paid no income tax in 1966. It is not the same as ordinary income tax or employment tax, and is calculated according to its own rules.

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danger AMT is relevant to you if you’re reading this. It’s important to understand because exercising ISOs can trigger AMT. In some cases a lot of AMT, even when you haven’t sold the stock and have no money to pay. We discuss this later.

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Source: IRS and the Tax Foundation

A bit on how all this fits together:

  • Ordinary income tax applies in the situations you’re probably already familiar with, where you pay taxes on salaries or wages. Tax rates are based on filing status (if you are single, married, or support a family), and on which income bracket you fall under.
  • Income brackets: For ordinary income, as of the 2018 tax year, there are income brackets at 10%, 12%, 22%, 24%, 32%, 35%, and 37% marginal tax rates—see Notice 1036 or a Tax Foundation summary. Be sure you understand how these brackets work, and what bracket you’re likely to be in.

    • confusion There is a popular misconception that if you move to a higher bracket, you’ll make less money. What actually happens is when you cross certain thresholds, each additional (marginal) dollar you make is taxed at a slightly higher rate, equal to the bracket you’re in. After you earn more than your deduction, on which you pay no tax, your post-tax income looks like the diagram above. (More discussion on such misconceptions are in this Reddit thread.)
  • Investment gains, such as buying and selling a stock, are similarly taxed at “ordinary” rates, unless they are long-term, which means you held the asset for more than a year.
  • You also pay a number of other federal taxes (see a 2018 summary for all states), notably:

  • Ordinary federal income tax, Social Security, and Medicare taxes are withheld from your paycheck by your employer and are called employment taxes.
  • important Long-term capital gains are taxed at a lower rate than ordinary income tax: 0%, 15%, or 20%. This covers cases where you get dividends or sell stock after holding it a year. If you are in the middle brackets (more than about $37K and less than $413K of ordinary income), your long-term capital gains rate is 15%. You can find more detail on tax brackets at the Tax Foundation.
  • AMT is a complex part of the federal tax code most taxpayers don’t worry about. But it comes into play when exercising ISOs. Most people do not pay AMT unless it is “triggered” by specific situations, typically high income (more than $500K) or high deductions. Whether you pay AMT also depends on the state in which you file, since your state taxes can significantly affect your deductions. If you are affected,