How to Structure Equity Grants to Attract and Retain Talent

Equity compensation is a strategic tool that allows companies to offer ownership in the business as part of employee compensation. For startups and scaling businesses, equity is often used to attract high-caliber talent, especially when offering competitive cash salaries isn’t feasible.

When structured correctly, equity compensation can help align employee motivation with the company’s long-term success. However, choosing the right type of equity and understanding its implications is crucial to avoid legal, tax, and operational risks.

This guide explains the most common types of equity compensation, outlines how to design a plan, and shares best practices for managing equity as your company grows.

Companies typically offer several types of equity-based incentives. Each type has its own structure, vesting mechanics, and tax implications.

Stock options grant employees the right to purchase company shares at a predetermined price, known as the exercise or strike price, after a specified vesting period.

• Incentive Stock Options (ISOs): Exclusive to employees, ISOs offer potential tax advantages. Employees can purchase shares at the strike price and, if they hold the shares for more than one year after exercise and two years after the grant date, may qualify for long-term capital gains tax rates on the appreciation. However, exercising ISOs may trigger the Alternative Minimum Tax (AMT).
• Non-Qualified Stock Options (NSOs): Available to employees, directors, contractors, and others, NSOs do not qualify for special tax treatments. Upon exercising NSOs, the difference between the strike price and the market value is taxed as ordinary income.

• Grant: The company provides the employee with the option to purchase a specific number of shares at the strike price.
• Vesting: Options typically vest over time (e.g., 4 years with a 1-year cliff), incentivizing employees to remain with the company.
• Exercise: Once vested, employees can exercise their options by purchasing shares at the strike price, regardless of the current market value.
• Sale: After exercising, employees may hold or sell the shares, with tax implications depending on the holding period and type of option.

RSUs are company shares granted to employees, subject to vesting conditions. Unlike stock options, RSUs do not require employees to purchase shares; instead, shares are delivered upon vesting.

• Grant: The company promises to deliver a specific number of shares upon meeting vesting criteria.
• Vesting: RSUs vest over time or upon achieving performance milestones.
• Delivery: Once vested, shares are delivered to the employee.
• Taxation: The value of the shares at vesting is taxed as ordinary income. Employees may sell some shares to cover withholding taxes.

ESPPs allow employees to purchase company stock at a discount, often through payroll deductions over a set offering period.

• Enrollment: Employees enroll in the plan and choose a contribution level, typically a percentage of their salary.
• Offering Period: Contributions accumulate during this period, usually 6 to 12 months.
• Purchase: At the end of the offering period, accumulated funds are used to purchase company stock at a discount, often up to 15% off the market price.
• Taxation: Tax treatment varies based on holding periods and plan specifics. Generally, the discount may be taxed as ordinary income, with additional taxes upon sale depending on holding periods.

RSAs involve granting actual shares to employees, subject to vesting conditions. Unlike RSUs, employees own the shares upon grant but face restrictions until vesting.

• Grant: Employees receive shares upfront, with restrictions.
• Vesting: Shares vest over time or upon meeting performance goals.
• Taxation: Employees can elect to be taxed at the time of grant (via an 83(b) election) or upon vesting. The 83(b) election allows taxation at the current share value, potentially resulting in lower taxes if the share value increases.

While less common in early-stage companies, phantom equity instruments provide cash bonuses tied to company valuation without actual share ownership. These tools can be used when equity dilution is a concern or for international teams where stock options are complex.

Typical Equity Allocation by Role

Allocating equity requires careful consideration of the company’s stage, industry standards, and individual contributions. Below are example equity ranges for early-stage startups:

Role	Equity Range (% of Company)
Chief Executive Officer (CEO)	5% – 10%
Chief Operating Officer (COO)	2% – 5%
Vice President (VP)	1% – 2%
Director	0.4% – 1.25%
Lead Engineer	0.5% – 1%
Senior Engineer	0.33% – 0.66%
Manager or Junior Engineer	0.2% – 0.33%

Source: Holloway Guide to Equity Compensation

These allocations can vary based on factors such as company valuation, funding stage, and negotiation. It’s essential to balance attracting talent with preserving equity for future hires and investors.

How to Build an Equity Compensation Plan

Creating an equity compensation plan involves more than just issuing stock. You’ll need to align your equity strategy with hiring goals, legal requirements, and financial planning.

1. Define Your Goals

Clarify what you want your equity plan to achieve:

• Attract early-stage employees in lieu of high salaries
• Retain talent through long-term incentives
• Align employee outcomes with business performance

2. Choose the Right Equity Types

Your company’s stage and financial position will guide your choice of instruments:

• Stock Options (ISOs or NSOs) are common for early-stage companies.
• RSUs are easier to manage at later stages or if going public.
• RSAs can be ideal for founders and very early hires.

3. Set Vesting Schedules

Vesting encourages retention by requiring employees to stay for a certain period before earning their equity.

• Standard schedule: 4 years with a 1-year cliff
• Consider performance-based vesting for leadership roles
• Include vesting terms in offer letters and stock agreements

4. Establish an Option Pool

Most startups set aside 10–20% of total shares in an equity pool for current and future employees.

• Adjust the pool size as you raise additional funding
• Communicate the purpose of the pool to investors and team members

5. Use Cap Table Management Tools

Equity management platforms simplify administration:

• Track ownership and vesting schedules
• Prepare accurate financial statements and reports
• Model dilution scenarios and grant history

Popular tools include:

• Carta
• Pulley
• Morgan Stanley at Work

6. Ensure Legal and Tax Compliance

Work with legal counsel to draft proper documents:

• Stock option agreements
• Restricted stock agreements
• 83(b) election forms

Ensure compliance with IRS Section 409A, which requires regular valuation of private company shares to set fair strike prices.

7. Communicate Equity Value

Employees often misunderstand equity. Help them understand:

• How vesting works
• What their shares are worth now vs. in the future
• How liquidity events (like an IPO or acquisition) affect their holdings

Provide equity education during onboarding and revisit during performance reviews or major funding events.

8. Plan for Dilution

As new funding rounds occur, ownership percentages change. Prepare your team:

• Show how future investment affects their shares
• Be transparent about dilution and potential value over time

Benefits and Risks of Equity Compensation

Benefits

• Conserves cash while offering competitive compensation
• Drives employee engagement through ownership and shared goals
• Improves retention with time-based incentives

Risks

• Over-dilution of founder and early investor equity if not carefully managed
• Tax complications, especially with ISOs and 83(b) elections
• Complex administration, requiring legal, HR, and finance alignment

• Carta – Manages cap tables, equity grants, and 409A valuations.
• Pulley – Ideal for early-stage startups tracking stock ownership.
• AngelList Stack – Handles incorporation, equity grants, and fundraising.
• Holloway’s Guide to Equity – A deep dive into startup equity structures.

Equity compensation is one of the most effective ways for startups to attract, motivate, and retain top talent—especially in competitive industries like SaaS, digital marketing, e-commerce, and HealthTech. However, designing an effective plan requires careful planning, legal compliance, and clear communication with employees.

By following best practices, leveraging the right tools, and staying informed about equity trends, startups can use equity compensation to build a strong, committed team while preserving long-term financial health.