How to Grant Equity to Employees: A Founder's Complete Guide

Why Grant Equity at All?

Equity aligns incentives. When employees own a piece of the company, they think like owners. This is especially important in early-stage startups where:

• Salaries are often below market rate
• The work is risky — the company might fail
• Success depends on everyone going above and beyond

Equity is also a powerful recruiting tool. Top candidates often compare offers not just on salary, but on potential upside. A well-structured equity package can help you compete with bigger companies.

Standard Equity Grants by Role

While every situation is unique, here are typical equity grant ranges by role and stage:

Role	Pre-Seed	Seed	Series A
Founding Engineer (#1)	2% - 5%	1.5% - 3%	0.8% - 2%
Early Engineer (#2-5)	0.5% - 2%	0.3% - 1%	0.2% - 0.8%
Senior Engineer	0.3% - 1%	0.2% - 0.5%	0.1% - 0.3%
Head of Product/Design/Sales	1% - 3%	0.5% - 1.5%	0.3% - 0.8%
Individual Contributor	0.1% - 0.5%	0.05% - 0.3%	0.02% - 0.15%

These are on a fully-diluted basis — meaning as a percentage of the company after all outstanding options, including unallocated options in your pool.

Vesting Schedules 101

Vesting protects both you and the employee. Employees earn their equity over time, and if they leave early, you don't give away equity for minimal contribution.

Standard vesting schedule:

• 4-year total vesting period — The industry standard
• 1-year cliff — No equity vests until the employee completes 1 year of service
• Monthly vesting after cliff — 1/48 of their grant vests each month

Example: An employee granted 48,000 options with a 1-year cliff vests 1,000 options per month after the first year. If they leave after 18 months, they leave with 6,000 vested options (12 months after cliff + 6 months).

ISO vs NSO: Which Should You Use?

There are two main types of stock options you can grant:

Incentive Stock Options (ISOs)

• Tax advantage: Qualified employees pay no tax on grant and only capital gains tax on sale (if held > 1 year after exercise and > 2 years after grant)
• Restrictions: Only available to employees (not contractors), max $100K grant value per year, must be issued at FMV strike price
• AMT risk: Can trigger Alternative Minimum Tax if spread between strike and FMV is large

Non-Qualified Stock Options (NSOs)

• Flexibility: Can be granted to anyone (employees, contractors, advisors)
• Tax treatment: Ordinary income tax on the spread at exercise (strike vs FMV), then capital gains on sale
• No limits: No $100K cap, no AMT issues

Factor	ISO	NSO
Who can receive	Employees only	Anyone
Max annual grant	$100K FMV	No limit
Tax at exercise	None (unless AMT)	Ordinary income on spread
Tax at sale	Capital gains (if qualified)	Capital gains
AMT risk	Yes	No

Setting the Strike Price

The strike price is what employees pay to exercise their options. It must be at or above the fair market value (FMV) determined by your 409A valuation.

Why FMV matters:

• Too low = Tax consequences for employees (IRS scrutiny)
• Too high = Less upside for employees (less attractive)

Your 409A valuation determines the FMV. For example:

• 409A valuation: $5M
• Outstanding shares: 10M
• FMV per share: $0.50
• Strike price: $0.50 (must be ≥ FMV)

Employee upside = Exit price - Strike price. The lower your 409A valuation (and thus strike price), the more upside for employees. This is why some founders aim for lower 409A valuations when hiring is a priority.

The Granting Process: Step-by-Step

1. Determine the grant size

Use the ranges above as a starting point. Adjust based on:

• The candidate's experience and impact potential
• How early they're joining
• Salary trade-offs (more equity = lower salary is acceptable)
• Market competition (are other offers on the table?)

2. Choose the option type

ISOs for employees under the $100K cap. NSOs for everyone else or for additional grants.

3. Get board approval

Most option grants require board approval. Have this process documented and efficient so you don't lose candidates while waiting.

4. Issue the stock option agreement

This legal document specifies: grant size, vesting schedule, strike price, exercise window, and other terms. Work with a lawyer to have a standard template.

5. Send 409A notice

When you grant options, you typically need to provide the employee with a 409A notice (a simple document showing the FMV per share).

6. Track everything in your cap table

Update your cap table immediately after each grant. Include: employee name, grant date, grant size, strike price, vesting schedule, and exercise status.

Common Mistakes to Avoid

1. Granting too much to early employees

It's tempting to be generous, but remember that early grants dilute everyone. A 5% grant to employee #1 means less equity for everyone who follows, including future co-founders.

2. Not having a 409A valuation

Setting strike prices without a 409A valuation is risky. If the IRS determines your strike price was below FMV, employees face immediate tax consequences and your company can face penalties.

3. Unclear vesting terms

Be explicit about vesting. What happens if the employee is fired vs quits? Is there an acceleration clause on acquisition? Ambiguity leads to disputes.

4. Forgetting about exercise windows

Standard practice: 90 days to exercise after termination. Some startups offer 10 years for terminated employees, which is more generous but means more unexercised options sitting on your books.

5. Not refreshing the option pool

As you grow, you'll need more options for new hires. Plan for pool refreshes in future funding rounds, or you'll run out.

Key Takeaways

• Equity aligns incentives and helps attract top talent
• Standard grants: 0.5-5% depending on role and stage (on a fully-diluted basis)
• Use standard vesting: 4-year total, 1-year cliff, monthly thereafter
• Grant ISOs to employees (under $100K cap), NSOs to everyone else
• Strike price must be at or above 409A FMV — get a 409A valuation before granting
• Track all grants in your cap table immediately
• Plan for option pool refreshes as you grow
• Be clear about vesting terms, exercise windows, and termination scenarios