Guide · Business
Understanding Equity Compensation: Options, RSUs, and How to Value Them
Equity can be the most valuable part of your compensation package—or an expensive distraction. The difference usually comes down to understanding the type, the vesting schedule, and the tax rules before you sign.
The three main forms of equity compensation
Stock options give you the right to buy shares at a fixed price (the strike price or exercise price) at some point in the future. The value is the difference between the current share price and the strike price. In the US, options come in two varieties: Incentive Stock Options (ISOs), which have favourable tax treatment but come with restrictions; and Non-qualified Stock Options (NSOs), which are taxed as ordinary income on the spread at exercise. In the UK, the equivalent tax-advantaged scheme is called EMI (Enterprise Management Incentives).
RSUs (Restricted Stock Units) are simpler—the company promises to give you actual shares once vesting conditions are met. You do not need to pay anything to receive them. The typical vesting schedule is four years with a one-year cliff. RSUs have value as long as the share price is above zero, making them lower-risk than options but with less upside leverage.
Direct share grants are less common outside of co-founder situations. You receive shares immediately, usually at a very low valuation (for a startup) or as part of a bonus at a listed company.
Options vs RSUs: a comparison at different share prices
The table below compares the intrinsic value of 10,000 stock options with a $10 strike price against 10,000 RSUs at various share prices. Options only have value above the strike price; RSUs always have value equal to the share price.
| Share price | Options value | RSUs value | Difference (RSU advantage) |
|---|---|---|---|
| $10 (at strike) | $0 | $100,000 | +$100,000 |
| $15 | $50,000 | $150,000 | +$100,000 |
| $20 | $100,000 | $200,000 | +$100,000 |
| $30 | $200,000 | $300,000 | +$100,000 |
| $50 | $400,000 | $500,000 | +$100,000 |
The RSU advantage is always equal to the strike price × number of units ($10 × 10,000 = $100,000 here). Options provide greater leverage at high prices because you spent less to acquire them—but they require the price to exceed the strike price to have any value at all.
Tax rules: ISOs, NSOs, EMI, and the 83(b) election
In the US, ISOs offer potentially favourable tax treatment—if you hold the shares for at least two years from grant date and one year from exercise, gains are taxed at the long-term capital gains rate rather than ordinary income rates. However, the spread at exercise is still an Alternative Minimum Tax (AMT) preference item, which can create unexpected tax bills. ISOs must also be exercised within 90 days of leaving employment or they automatically convert to NSOs. NSOs are taxed as ordinary income on the spread at exercise—simpler, but potentially at rates as high as 37% federal plus state taxes.
The 83(b) election is a US tax strategy relevant when you receive unvested shares (not options) at a low valuation. By filing within 30 days of receiving the shares, you elect to pay income tax on the current (low) fair market value immediately, rather than paying tax on the much higher value at the time of vesting. If the company grows significantly, this can save a substantial amount. The risk: if you leave before vesting or the company fails, you have paid tax on shares you forfeited and cannot reclaim it.
In the UK, EMI options are the most tax-advantaged form. Gains from EMI options are subject to Capital Gains Tax at the 10% Business Asset Disposal Relief rate (subject to a lifetime limit of £1 million in gains), rather than Income Tax at up to 45%. EMI schemes are only available to qualifying companies (broadly: fewer than 250 employees, gross assets under £30 million). UK employees at larger companies typically receive options taxed as unapproved options (similar to US NSOs) or RSUs taxed as employment income.
Vesting, cliffs, and acceleration
Vesting schedules determine when you earn the right to your equity. A standard four-year schedule with a one-year cliff means nothing vests in the first 12 months; 25% vests on the anniversary, then the remaining 75% vests in equal monthly or quarterly instalments over three years. This structure protects companies from employees who leave early taking large equity stakes with them.
Acceleration clauses can modify this. Single-trigger acceleration vests all or some equity upon a change of control (acquisition). Double-trigger acceleration requires both a change of control and termination without cause. Double-trigger is more common for employees; single-trigger occasionally appears for founders. If you are negotiating an equity package, checking for double-trigger acceleration is worthwhile—acquisitions frequently result in employees being made redundant shortly after closing.
Frequently asked questions
What is a vesting cliff?
A vesting cliff is the minimum period you must stay at a company before any equity vests. The most common arrangement is a four-year schedule with a one-year cliff: nothing vests for the first 12 months, then 25% vests all at once on your one-year anniversary, with the remainder vesting monthly or quarterly over the following three years. If you leave before the cliff, you receive nothing.
Should I exercise stock options early?
Early exercise (before vesting) can make sense for tax reasons if the current fair market value is close to the strike price, because you lock in a low taxable gain. In the US, early exercise combined with an 83(b) election means you pay tax on the small spread now rather than on the (potentially much larger) spread later. However, early exercise requires capital outlay and carries risk—if the company fails, you lose both the shares and the tax paid.
What are RSUs and how are they taxed?
Restricted Stock Units (RSUs) are a promise to deliver shares on a future date, once vesting conditions are met. Unlike options, RSUs have value even if the share price stays flat—they are simply shares granted at no cost. In the UK and US, the market value of shares on the vest date is treated as employment income and taxed accordingly (Income Tax and NI in the UK; ordinary income tax in the US). There is no exercise decision to make.
What happens to my options if I leave the company?
Unvested options are typically forfeited immediately on leaving. Vested options must usually be exercised within a short window—commonly 90 days for ISOs in the US (after which they convert to NSOs) and often 90 days for UK EMI options before favourable CGT treatment is lost. Some companies offer extended exercise windows of up to 10 years, which is a significant employee-friendly feature worth checking in your option agreement.