Employee stock options are no longer just a Silicon Valley perk. These days, they’ve become a standard tool for startups across the world, which includes India’s booming tech scene. When startups can’t always afford to match the salaries of established giants, they use stock options to give employees a tangible stake in the company’s success. It’s ownership with upside potential, and for many, it’s a bet worth taking.
A Slice of the Startup Cake
Stock options give employees the right to buy company shares at a set price, often lower than market value. If the company grows, that strike price can turn into a major payday. It’s a simple equation: if the startup thrives, so do its early believers. For startups, this setup solves two problems. First, it attracts skilled workers who might otherwise be lured by higher pay at larger firms.
Second, it keeps them around. Most employee stock option plans (ESOPs) have vesting schedules that reward long-term commitment. In most cases, a four-year plan with a one-year cliff is common. This means employees must stay a year before earning any options and continue to earn them gradually over the next three years. Startups often call this “sweat equity”, as team members put in time and effort before they can cash in. It turns work into investment and employees into stakeholders.
The U.S. Model: ISOs vs NSOs
In the United States, stock options are generally classified into two categories: Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs). Both give employees the right to buy shares, but they’re taxed differently.
Learning how stock options are taxed in the U.S. helps explain why understanding equity compensation is so critical. ISOs are typically offered to top executives and enjoy special tax treatment. If certain holding conditions are met, profits are taxed as long-term capital gains rather than ordinary income.
On the other hand, NSOs are available to more employees. However, they are taxed as regular income when exercised since the discount (the spread) is viewed as part of the worker’s compensation.
This can be a complicated process, which is why the IRS provides detailed guidance on the taxation of ESOs. Employees must also remember that simply exercising options can trigger a tax event. This happens even before any sale of shares occurs.
As a startup founder, you need to learn about tax rules for U.S. stock exchange so that you know what taxes apply to private company shares. Doing this will also help you learn how they differ from public market rules.
The Indian Parallel
In India, startups have adopted ESOPs as a critical part of compensation packages. However, taxation remains a sore spot. In most cases, employees are often taxed twice. The first time is when they exercise the option and the second time when they sell the shares. Double taxation can reduce the financial benefit. This is usually the case when startups remain private for years before a liquidity event like an IPO or acquisition.
Endnote
Stock options aren’t a guaranteed windfall, but they’ve reshaped how startups compensate and motivate employees. They turn a job into a partnership and success into something shared.
