I’m excited to share my third newsletter which is An Employee’s Guide to 5 Types of Equity Incentive Compensation.
There’s a lot of good detail in here but one takeaway from preparing it all is – if you have a question about your own equity, please get in touch. Every situation is unique and worth an individualized look. I’m happy to speak so please reach out to schedule a time to speak!
Intro
My first exposure to equity was receiving restricted stock (RSUs) while on Wall Street. I’m embarrassed to admit that, at the time, I thought it was a partial step back – just my employer’s way of preserving cash (and maybe it partly was). But, now, I appreciate that equity can be one of the most powerful parts of someone’s financial plan.
I’ve spent my career helping businesses’ launch, build and realize their equity value – first as an investment banker, then equity analyst and later as a CFO. So, I know that the most vital part of equity ownership is the value creation.
So, why write this newsletter? As financial advisor, I also know that understanding the rules for each type of equity may make a difference in how much you ultimately keep.
That’s why I ran a 5-part LinkedIn series on these 5 common types of equity incentive compensation and how to navigate them. This newsletter pulls it all together in one place to serve as your reference guide. I hope you find it helpful!
Scroll Down this Newsletter to Expand on the Following:
1. Restricted Stock (RSAs & RSUs)
- 83b elections for RSAs must be filed within 30 days but can potentially provide significant tax savings
- RSUs are taxed as ordinary income as they vest so be sure to review withholding as W-2 withholding is often only at 22% Federal causing a potential surprise tax bill.
2. Stock Options (ISOs & NSOs)
- A common strategy for both ISOs and NSOs is to exercise early when the share value is lower in order to potentially reduce taxes and starting the capital gains holding period sooner.
3. Founder’s Stock
- 83b elections and QSBS eligibility can potentially provide significant tax savings.
4. Carried Interest (Carry in a Fund)
- Plan for high-income years when receiving distributions with estimated taxes / extra withholding.
5. LLC Units
- LLCs provide flexibility via pass-through taxation but members may still owe tax on allocated profits before receiving cash distributions, depending on the LLC agreement.
6. Stage-by-Stage Strategies
- From grant to exit, key planning checkpoints help you keep more of what you earn!
7. A Note on the 83b Election:
- Allows you to pay ordinary income tax upfront when receiving equity with restrictions, locking in today’s lower value and starting the long-term capital gains clock. This is available when you receive actual stock or units subject to vesting (e.g., Founder’s Stock, RSAs, or LLC profits interests) but does not apply to RSUs or stock options. Most importantly, filing must be done within 30 days of grant. Note the applicability and benefit of strategies like the 83b election or QSBS exclusion depend on your individual circumstances and current tax law. You should consult your personal tax advisor before making any election or transaction.
1. Restricted Stock (RSAs & RSUs)
There are two types of restricted stock – RSAs (Restricted Stock Awards) and RSUs (Restricted Stock Units) – which sound similar but have different outcomes. For both, planning ahead for tax withholding and vesting dates is important.
Highlights:
- RSA = actual shares now, common in early-stage startups & founders; typically forfeitable if you leave early. An 83b election within 30 days lets you pay ordinary income tax on today’s low value so future growth is capital gains; best when value is very low and you’re confident in the upside.
- RSU = no stock until vesting; common in public companies & later-stage firms; taxed as ordinary income upon vesting (often W-2 withholding at 22% Federal which may be below your true bracket so planning for withholding and liquidity is critical. Be sure to mark vesting dates and plan for cash / liquidity needs and decide if you want to sell-to-cover for taxes or hold for long-term capital gains.
2. Stock Options (ISOs & NSOs)
Two common types of stock options are ISOs (Incentive Stock Options) and NSOs (Non-Qualified Stock Options). Exercising ISOs in a low-income year can reduce AMT (Alternative Minimum Tax) exposure and lock in long-term capital gains. ISOs may qualify for favorable tax treatment if strict holding rules are met – while NSOs are taxed as ordinary income at exercise. Both require proactive planning to balance tax impact, cash needs and timing.
Highlights:
- ISOs: Granted only to employees; potential long-term capital gains treatment, but watch strict 2-year (grant) + 1-year (exercise) holding rules and AMT exposure. Early exercise when value is low can reduce AMT risk (cash planning required).
- NSOs: Can be granted to employees, contractors & advisors; ordinary income at exercise on the spread; growth after exercise taxed as capital gains. Withholding is often only 22% federal – many professionals need additional withholding / estimates to avoid surprises.
- Track expiration dates and model exercise timing vs. changes in your tax bracket.
3. Founder’s Stock
Founder’s stock represents the earliest ownership in a company, often issued at formation at pennies per share. Because of this potentially low basis, an 83b election within 30 days of receipt can be critical. Further, the potential to qualify as Qualified Small Business Stock (QSBS) can mean the potential for up to 100% of your gain to be excluded from Federal tax capped at the greater of $15M (recently raised from $10M by the OBBB though final IRS guidance may impact application) or 10x your cash investment / basis (kept the same).
Highlights:
- Typically issued early at low cost; often vesting/buyback terms apply.
- 83b election within 30 days for stock grants (founder shares/RSAs, not options) where you pay ordinary income tax on today’s value so later growth is capital gains; forfeiture/decline risk remains.
- QSBS potential can mean up to 100% gain exclusion at exit if requirements are met (C-Corp, active business, gross asset limitation at issuance, up to 5 year hold, etc.). Build QSBS planning into your exit timeline and keep meticulous records(grants, valuations, elections).
4. Carried Interest
Carried interest (“carry”) can be a tremendous opportunity to build wealth – but it may be one of the lesser understood forms of equity because it’s not company stock. Rather, it’s a share of fund profits often vesting over time and paying out only if performance hurdles are met. No tax applies at grant or vest but profits are taxed when distributed, often at long term capital gains rates (with 3+ year hold on underlying assets) if structured correctly.
Highlights:
- Typically structured as a profits interest in a PE/VC/Hedge fund for employees (not stock). Value depends on fund performance, generally vests over years and can be forfeited if you leave early. Often pays only after investors receive capital back and the fund clears a preferred return hurdle.
- Taxes: Properly structured profits interests are usually not taxed at grant or vest (assuming no upfront value). Taxable events occur when the fund exits, allocates profits and distributes cash (K-1). Long-term capital gains often require 3+ years on underlying assets.
- 83b: Many funds encourage an 83b at grant (even if no value) to lock in that position and start the holding clock; be sure to confirm your fund’s guidance.
5. LLC Units
LLC units are a common way to share ownership in real estate ventures & small businesses. LLCs are typically taxed as pass-through entities so income flows directly to your tax return, creating flexibility but also obligations especially when profits are allocated without distributions (i.e., you may owe tax on income whether or not cash is distributed). LLC ownership can be capital interests (current value) or profits interests (future growth) with 83b elections often relevant for the latter.
Highlights:
- Capital interest = current value (often cash in); can be taxable if received below FMV.
- Profits interest = future appreciation; often no tax at grant if structured properly. If subject to vesting, an 83b may be appropriate.
- Liquidity often restricted; value tied to buy-sell terms and exit.
- Taxes > Single-member LLC (default) = disregarded entity (no K-1); income reported on your personal tax return.
- Taxes > Multi-member LLCs are generally taxed as partnerships issuing K-1s to members. In that case, an investor could owe tax on allocated profits even without receiving cash distributions unless the LLC agreement requires tax distributions. Actual treatment depends on the LLC’s structure and governing terms.
- Taxes > LLCs can also elect S-Corp or C-Corp taxation (different rules to understand, no partnership K-1 under C-Corp).
6. Strategies to Navigate Each Stage
From grant to exit, equity planning isn’t one decision but a series of checkpoints which can help you keep more of what you earn. Strategy evolves with each stage – from early elections to exercise timing, diversification and eventual exit planning.
6 Stages of Equity Ownership:
1. Negotiate and benchmark your terms (strike, vesting, acceleration) and run scenarios to understand upside potential.
2. Vesting: know tax triggers – RSU/RSA vest, NSO exercise, ISO AMT.
3. Hold/sell: balance concentration vs. diversification; track ST/LT clocks and QSBS timelines; don’t lose ISO AMT credits.
4. Early liquidity: use secondaries to de-risk; mind tax timing.
5. Pre-exit: tax bracket management, Roth conversions if in lower tax bracket now, understand state residency impact, align exit with broader tax plan (QSBS, charitable giving, estate planning).
6. Post-exit: plan for ordinary and capital gains; offset where possible to redeploy, diversify and protect.
Important Disclosure: Olivehurst Advisors LLC (OA) is a Registered Investment Adviser in the state of California. Advisory services are only offered to clients or prospective clients where OA and its representatives are properly registered or exempt from registration. Neil Portus is an investment adviser representative of OA. Registration as an investment adviser is not an endorsement of the firm by securities regulators and does not mean the adviser has achieved a specific level of skill or ability. The information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed and not to be considered financial, legal, accounting or tax advice. “Likes” should not be considered a positive reflection of the investment advisory services offered by OA and any comments should not be construed as an offer to buy or sell, or a solicitation of an offer to buy or sell the investments mentioned. A professional adviser should be consulted before implementing any of the strategies discussed. Investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. All investment strategies can result in profit or loss. Should you follow a link contained herein and view content that is not provided by OA, you do so at your own risk. OA makes no representations as to, and shall have no liability for, any electronic content delivered by any third party, including, without limitation, the accuracy, subject matter, quality, or timeliness of any electronic content.
Tax and legal rules (including 83b elections, QSBS eligibility and carried interest treatment) are complex, subject to change and may not apply in all situations. Always consult your qualified accounting, tax or legal professional regarding your specific circumstances before making any financial, tax or investment decisions.