A Comprehensive Guide to Startup Compensation and Equity

Key Takeaways

• Startups typically allocate 13% to 20% of total equity to employees.
• Most equity plans include a 4-year vesting schedule with a 1-year cliff.
• ISOs and NSOs are the most common stock options, but RSUs and phantom equity are growing.
• Equity offers vary by stage, early-stage hires receive more equity, later hires see higher base salaries.
• 409A valuations are essential for compliant and defensible option pricing.

Introduction 

Hiring top talent without deep pockets is a balancing act. You're expected to compete with large companies offering cash-heavy packages while your startup is still managing burn and chasing growth milestones. It's not just about paying well; it's about making the offer feel worthwhile. Equity often fills that gap. 

On average, startups reserve between 13% and 20% of their total cap table for employee equity. That pool gets carved up across early hires, executives, refresh grants, and retention packages. Stretch it too thin, and you lose hiring power. Make it too generous, and founders and investors push back.

In this blog, you will get a clear, structured look at how startup equity compensation works, what the key instruments are, how to design a competitive offer, when to use it, and how to communicate it well.

What Is Startup Equity Compensation?

Equity compensation means giving employees partial ownership in your company. It’s a promise that if the business grows, their personal stake grows too. For many startups, this isn't just a perk; it’s a hiring tool and a long-term incentive.

At early stages, equity can carry more weight than salary. It’s what helps you bring on strong talent when budgets are tight. And even as your startup grows, equity keeps employees invested, literally, in the outcome.

Let’s break down what it looks like.

What Equity Really Means?

Equity usually refers to a slice of company ownership, offered through stock options, restricted stock units (RSUs), or phantom stock. Each one works differently, but the idea is the same: employees benefit if the company’s value goes up.

The ownership isn’t immediate. It’s earned over time, through a vesting schedule. And it’s affected by the company’s valuation, cap table, and funding milestones.

For example:

• An employee might be granted 10,000 stock options at a $1 strike price.
• If the company exits at $10/share, they stand to gain $90,000 (minus taxes), if their options are fully vested and exercised.

That’s the promise on paper. But getting there involves a lot of detail and potential friction.

Why It Matters to HR, CPOs, and Finance?

For Chief People Officers and HR teams, equity is part of your compensation story. It needs to be competitive, but also transparent. If it’s misunderstood, it can backfire.

For Finance, it’s not just about modeling dilution, it’s about ensuring compliance, planning for 409A valuations, and managing the equity pool across funding rounds.

Now that you know what it is, let’s look at how it plays out in practice.

How Equity Compensation Works?

Equity isn’t a one-time gift, it’s a contract over time. What you grant on paper can look generous. What actually vests and becomes exercisable? That’s the real number employees care about.

Let’s walk through how equity turns into something tangible and where things often get misunderstood.

Vesting Schedules & Cliffs

Most startups use a 4-year vesting schedule with a 1-year cliff. That means the employee earns nothing if they leave in the first year. After 12 months, 25% vests. The rest vests monthly (or quarterly) over the next three years.

Why? It protects the company from over-granting to short-term hires while still offering upside to those who stay.

Some companies add performance-based vesting or milestone-based vesting for leadership roles. But for most employees, time-based vesting keeps things simple.

Strike Price & Exercising Options

Equity isn’t free. If you offer stock options, the employee must buy them to own them. The strike price is what they pay per share. This price is usually tied to your 409A valuation at the time of the grant.

Here’s the catch: the value of equity depends on two things:

• The difference between strike price and future share value
• Whether the employee actually exercises those options (and when)

That’s where tax questions and cash concerns start piling up.

Dilution & Cap Tables

Every new round of funding affects your cap table. As you issue more shares to investors, advisors, or new hires, existing holders get diluted.

That includes employees.

A grant for “0.5% of the company” at Seed may turn into 0.2% after Series B. It’s still the same number of shares, but the pie has grown.

This is why people care about the total number of outstanding shares, not just their slice.

Knowing how equity behaves is key, but so is choosing the right instrument for each case.

Types of Equity Instruments

Not all equity works the same. Some require employees to buy shares. Others give shares outright. Some come with tax perks; others come with tax headaches.

Each option has trade-offs. You need to know what fits your stage, budget, and employee base.

ISOs (Incentive Stock Options)

These are only available to employees, not advisors or contractors. ISOs come with a potential tax break: if certain conditions are met, gains can be taxed at capital gains rates instead of ordinary income.

But ISOs come with rules:

• $100K limit per year (based on fair market value)
• Must be exercised within 90 days of leaving the company
• Subject to Alternative Minimum Tax (AMT) in some cases

Most early-stage startups use ISOs for U.S.-based employees. They’re popular but misunderstood.

NSOs (Non-Qualified Stock Options)

NSOs can be granted to employees, contractors, and board members. They don’t have the same tax perks as ISOs. Gains are taxed as income when exercised.

They’re more flexible. But from the employee’s perspective, they often lead to higher taxes.

Use NSOs for non-employees or when ISO limits are exceeded.

RSUs (Restricted Stock Units)

RSUs are promises to deliver stock in the future, usually after a vesting period. No need to buy shares or worry about strike prices. They’re taxed as income when they vest.

Biggest downside? RSUs are usually worth nothing at early-stage startups until there’s a liquidity event. That makes them more common in late-stage or post-IPO companies.

Phantom Stock / Stock Appreciation Rights

These are synthetic forms of equity. No actual shares change hands. Instead, the employee gets a cash payout (or stock) based on the value increase over time.

Phantom equity is often used in LLCs or in cases where real equity is too complex or risky to offer. The upside is flexibility. The downside is… it’s not ownership.

Once you’ve chosen the right type of equity, the next step is structuring the full offer.

How to Structure an Equity Compensation Package?

Every startup has its own budget, risk tolerance, and hiring needs. So there’s no one-size-fits-all approach. That said, a solid equity comp plan usually starts with two questions:
How much cash can we afford? And how much equity are we willing to trade?

Here’s how to build offers that make sense, both for your company and your hires.

Balance Cash and Equity by Stage

Early-stage startups often trade salary for upside. At Seed or Pre-Seed, founders may offer lower pay but larger option grants, say, 1–2% for early engineers.

By Series A or B, the mix changes. There’s more cash available, and investors are keeping a closer eye on dilution. That means smaller equity slices, but better-defined structures.

Later-stage startups tend to pay closer to market rates, with equity playing a secondary role.

Set Expectations by Role

Not every offer needs to be negotiated. Use benchmarks. For example:

• Entry-level engineer: 0.1%–0.3%
• Senior IC: 0.3%–0.7%
• Director: 0.6%–1.2%
• VP: 1.5%–2%
• C-level (non-founder): 2%–4%

These aren’t rules, they’re ballpark ranges. The point is to avoid guesswork.

Also: consider the person’s risk profile. A candidate leaving Big Tech might expect more cash to offset the risk. A serial startup hire might take a lower salary for more equity.

Document the Details

Use an offer letter that clearly shows:

• Number of shares (not just %)
• Strike price (if available)
• Vesting schedule
• Type of grant (ISO, NSO, RSU)
• Exercise window after departure

Now we’ll look at how equity grants typically vary across roles and funding rounds.

How Much Equity to Give?

There’s a fine line between too generous and too stingy. Give too much and you’ll struggle with dilution later. Give too little and top talent walks.

Here’s how companies figure out the right numbers.

Build an Option Pool That Matches Hiring Plans

Early-stage startups typically set aside 10%–20% of fully diluted shares for their employee option pool. That pool covers current hires, future roles, and refresh grants.

Example: If you expect to hire 15–20 people before your Series A, a 15% pool might be safe. You can always top it up later but keep in mind that investors often ask for this pool before their shares are priced. That means the dilution hits founders first.

Equity by Role: Common Ranges

While ranges vary, here’s what many U.S. startups offer at the time of hire:

Seed Stage:

• Software Engineer (mid-level): 0.3%–0.7%
• Product Manager: 0.3%–0.6%
• Head of Sales: 0.5%–1.5%
• COO: 2%–5%

Series A:

• Software Engineer: 0.2%–0.4%
• PM: 0.2%–0.4%
• Head of Sales: 0.4%–1%
• COO: 1.5%–3%

Series B:

• Software Engineer: 0.1%–0.25%
• PM: 0.1%–0.25%
• Head of Sales: 0.3%–0.7%
• COO: 1%–2%

These numbers get smaller as the company matures but the value per share may grow.

Refresh Grants and Promotions

Equity isn’t a one-time deal. For key performers, you’ll need a system for refresh grants usually tied to tenure, role changes, or new responsibilities.

One common approach: a new grant every 2–3 years, often smaller than the original but still meaningful. This helps with retention and avoids surprises when original grants run out.

Before finalizing your equity plan, make sure you’ve covered the tax and legal side.

Tax & Compliance Essentials

Equity without tax planning is a trap. The numbers may look clean on a slide, but the fine print can cause headaches especially at exercise or exit.

Let’s look at what you need to stay legal, clear, and out of audit trouble.

409A Valuation

A 409A valuation sets the fair market value (FMV) of your common stock. You need this to issue stock options without triggering surprise taxes for your team.

Key points:

• Must be updated at least once every 12 months, or after any material event (like a new funding round).
• If you skip it or guess, you risk massive penalties under IRS Section 409A. That means back taxes and interest for your employees.

Use a third-party provider. It’s not worth cutting corners here.

ISO vs NSO Tax Timing

ISOs are taxed at exercise and sale. If the holding conditions are met (two years after grant and one year after exercise), gains are taxed at long-term capital gains rates.

But the AMT (Alternative Minimum Tax) can kick in. Employees often don’t know that. If they exercise a large grant without selling shares, they may owe tax on paper gains with no liquidity.

NSOs are simpler. They’re taxed as ordinary income at the time of exercise, based on the spread between strike price and FMV. No AMT, but more payroll tax for the company.

Explain both clearly to employees. Better yet offer to pay for a tax advisor during their first year if you can.

RSUs and Withholding

RSUs are taxed as income when they vest. No purchase required, but you do have to manage tax withholding. That can get messy if you’re not using a good system (like Carta, Pulley, or Shareworks).

Make sure your payroll and finance systems are talking to each other. Otherwise, someone’s going to be surprised and not in a good way.

With the mechanics and tax risks covered, let’s talk about when equity makes sense and when it doesn’t.

When to Offer Equity (and When Not To)

Equity can motivate, retain, and reward. But not every situation calls for it. Sometimes it confuses more than it helps or adds legal weight you don’t need.

Here’s how to make the call.

Offer Equity To:

• Full-time employees, especially early hires
• Key leaders with long-term influence
• Senior ICs who can move the needle
• Founding advisors with vesting and clear scope

These are the people whose effort ties closely to company value. Give them upside. Make sure it's structured. And make sure you can back it up with proper paperwork.

Be Cautious With:

• Contractors and freelancers: Use cash. Equity adds complexity with no guaranteed return for either side.
• Short-term advisors: A small cash stipend or gift can often do the job better.
• International hires: Tax treatment and compliance vary by country. You’ll need local counsel or a global employment platform if you're serious about offering equity.

Also, think about your cap table. Too many small grants that never vest? That clutters things up fast. Clean equity plans are easier to manage and easier to explain to investors.

Next, we’ll cover how to make equity make sense to your team without sounding like a lawyer or a cap table spreadsheet.

Communicating Equity to Employees

Equity isn't just numbers. It’s a story. If your team doesn’t understand what they’ve been granted or why it matters, your comp strategy falls flat.

This part isn’t about legal language or plan documents. It’s about clarity, consistency, and trust.

Break It Down, Plain and Simple

Avoid jargon. Use examples. Show employees what their options mean in dollars, timelines, and scenarios. Instead of saying, “You have 20,000 options,” say: w “You’ll own 20,000 shares, which is currently 0.2% of the company. If we exit at $10 per share, that’s $200,000 before taxes and exercise costs.”

Explain the vesting timeline. Clarify what happens if they leave. Walk them through strike prices and liquidity events without fluff or spin.

Use Tools to Make It Visual

Spreadsheets don’t tell a compelling story. Use platforms that show total comp, potential equity value, and how it changes over time. Interactive equity modeling tools help people see the upside and the risk.

You’re not just selling equity. You’re offering a seat at the table. Make sure people feel like they understand what they’re signing up for.

Conclusion 

Equity only works when it’s clear, consistent, and trusted. That takes structure and tools built for it.

CandorIQ helps you build and run comp plans that actually work. From equity offers and pay bands to approvals and headcount planning, everything lives in one place backed by data, not guesswork.

Cut the spreadsheets. Give your team clarity.

Book a demo with CandorIQ and simplify compensation from day one.

FAQs

Q: How often should we refresh employee equity grants?

A: Every 2–3 years is common, but use performance, role changes, or retention risks as signals. Build a system so refreshes don’t feel random or reactive.

Q: Can we grant equity before having a 409A valuation?

A: Technically yes, but it's risky. Without a valid 409A, you’re guessing the strike price. That can trigger tax penalties down the line. Always get one first.

Q: What’s a good way to explain equity to non-technical hires?

A: Use dollar examples, not percentages or share counts. Focus on potential outcomes tied to company growth. Avoid terms like “vesting” or “exercise” without breaking them down.

Q: How do we handle equity for international employees?

A: It depends on local tax laws. Some countries treat options harshly. Others require special plan structures. Always consult local legal/tax advisors before offering equity abroad.

Q: Should we give advisors equity upfront or on a vesting schedule?

A: Use a vesting schedule, usually 1 or 2 years with no cliff. That keeps expectations clear and avoids overcommitting if the relationship doesn’t last.

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