What Is Equity Compensation: RSUs, Stock Options, and How They Work

Equity compensation is any form of pay that gives you ownership in the company you work for. Instead of receiving only cash, you receive a stake in the business itself. If the company grows in value, your equity grows with it. If it declines, so does the value of what you hold.

For many professionals, especially those working in technology, finance, and startups, equity represents the largest single component of total compensation. Understanding how it works is not optional. Getting it wrong costs real money.

The three main types of equity compensation

RSUs and stock options are by far the most common forms of equity compensation for professional employees. ESPP is an additional benefit offered on top of the main equity grant at many public companies. This guide focuses primarily on RSUs and stock options since these represent the largest portion of equity value for most employees.

How RSUs work

An RSU is a promise from your employer to give you a specific number of company shares at a future date. The grant is made today, but the shares are delivered to you over time through a process called vesting. Until the shares vest they are restricted, which is where the name comes from.

When your RSUs vest you receive actual shares of company stock. Those shares are yours to keep, sell, or hold. At the moment of vesting the value of those shares is treated as ordinary income by the IRS and taxed accordingly.

The size of an RSU grant in your offer letter is expressed as a total dollar value at the current stock price. A $200,000 RSU grant means the company is granting you shares worth $200,000 today. Over a typical four-year vesting period you receive $50,000 worth of shares per year, assuming the stock price stays flat.

Understanding vesting schedules

Vesting is the process by which you gradually earn the right to your equity over time. Almost all equity grants at both public companies and startups include a vesting schedule. The most common structure is a four-year vest with a one-year cliff.

The cliff is the most important feature to understand. If you leave the company before your cliff date you receive zero equity regardless of how long you worked there. The day after your cliff, you own 25% of your grant outright. This structure is designed to encourage employees to stay through the first year before any equity changes hands.

How stock options work

A stock option gives you the right to buy company shares at a specific price called the strike price, also known as the exercise price. The strike price is set on the day of your grant and does not change. What changes is the market value of the stock itself.

If the stock rises above your strike price your options are said to be in the money. You can exercise them by paying the strike price to receive shares, and the difference between the strike price and the current market price is your gain. If the stock never rises above your strike price your options expire worthless.

Unlike RSUs, stock options require you to actively decide to exercise them. At a private startup this usually means waiting for a liquidity event. At a public company you can exercise and sell at any time after vesting.

RSUs vs stock options at a glance

How equity is taxed

RSUs are taxed as ordinary income at the moment they vest. If 1,000 shares vest when the stock is trading at $50, you have $50,000 of ordinary income that tax year regardless of whether you sell the shares. Your employer typically withholds a portion of the shares to cover the estimated tax owed, which is why you often receive fewer shares than you expected on vesting day.

Stock options have more complex tax treatment that depends on whether they are Incentive Stock Options or Non-Qualified Stock Options. ISOs get more favorable tax treatment but come with limitations and alternative minimum tax considerations. NSOs are taxed as ordinary income on exercise, similar to RSUs.

How much of your total compensation is equity

At public technology companies, equity typically represents 20 to 40% of total compensation for mid-level roles and 40 to 60% for senior roles. At startups the equity percentage on paper is often much higher but the real value depends entirely on whether a liquidity event happens and at what valuation.

Questions to ask about equity in any job offer

Before accepting any offer that includes equity, ask these questions. A company that cannot or will not answer them is a red flag.

For RSUs at a public company: what is the total grant value at today's price, what is the vesting schedule and cliff date, are refresh grants offered after the initial grant period, and what happens to unvested shares if the company is acquired?

For stock options at a startup: what is the current 409A valuation and what is the strike price, how many shares are outstanding on a fully diluted basis, what are the liquidation preferences on preferred stock, how long do you have to exercise options after leaving the company, and what is the company's most recent funding round and valuation?

The last question for startups is particularly important. If the company raised its last round two or more years ago and has not raised since, the 409A valuation may be significantly outdated. The current fair market value of the shares could be higher or lower than the official number, and your options' real value may be very different from what the offer letter implies.