RSUs vs Stock Options at an Early-Stage Company

Early-stage companies predominantly issue stock options rather than restricted stock units (RSUs) because options preserve cash, create lower accounting expense, and offer employees favorable tax treatment. RSUs, while simpler for employees, require companies to withhold cash taxes at vesting, consume more equity value per dollar of compensation, and trigger FASB 718 expense accounting charges that can constrain fundraising. For employees, this trade-off means understanding both the upside potential and the execution and tax risk embedded in options.

Why startups issue options, not RSUs

A startup issuing RSUs to an employee incurs three immediate costs. First, the company must withhold and pay employment taxes on the vesting date—if an employee vests 25,000 RSUs at a $2 per share fair value, the startup owes approximately $12,500 in payroll taxes. For a pre-revenue or low-revenue startup, this is real cash out.

Second, under standard accounting rules (ASC 718), RSUs are recorded as equity-based compensation expense each quarter, marked to market based on the stock price. A $1 million RSU grant at a $1 billion valuation will accrue $250,000 in annual expense. For a company that does not yet have predictable revenue, this accounting drag can weaken balance sheets and complicate fundraising rounds.

Third, RSUs are economically expensive: they vest at whatever fair value the company assigns, so 25,000 RSUs consume 25,000 shares of fully diluted equity. If those shares later become worth $50 each, the employee has received $1.25 million in value but the company gave up 25,000 shares of future upside.

Options, by contrast, cost the company nothing upfront. There is no cash withholding requirement when options are granted. The accounting expense is significantly lower under most valuation methodologies because the grant-date fair value (typically computed via Black-Scholes) is smaller than the current stock price. And most critically, if the stock appreciates after grant, the company gives away only the incremental gains beyond the strike price, not the full post-grant appreciation.

The tax case for options

In the United States, employees who receive properly structured incentive stock options (ISOs) owe zero ordinary income tax at exercise—they simply execute the option and own shares. When they later sell those shares, any gain between the exercise price and the sale price is taxed as long-term capital gain (at lower rates). Even non-qualified stock options (NSOs) defer taxation until exercise, at which point the employee owes ordinary income tax on the “spread” (the difference between fair value and the strike).

RSU vesting, by contrast, is a taxable event. On the vesting date, the full value of the vested shares is ordinary income to the employee, regardless of whether she sells the stock or holds it. An employee receiving $500,000 in RSU grants that vest over four years will face $125,000 in ordinary income tax annually for four years. If her income is high enough to trigger alternative minimum tax or phase-outs of deductions, the bill is even larger.

For early-stage employees (especially engineers and founders), the tax deferral and lower marginal rates offered by options are materially valuable. An option with a $2 strike that later sells for $50 generates $48 of long-term capital gain taxed at 20% (federal) rather than ordinary rates that might be 35%–37%, a difference of roughly 15 percentage points on every dollar of gain.

Dilution and the equity pool

Early-stage option pools are typically sized as a percentage of fully diluted equity—often 10–20% of post-money valuation. Each funding round refreshes expectations around how many options should be available to attract talent.

Because options are economically more efficient (the company only gives away gains above the strike), a startup can offer larger option grants for the same economic value. If a startup offers either 50,000 RSUs or 100,000 options at a $2 strike, the long-term dilution is similar or lower with options, especially if the stock appreciates. Employees like the larger number, and startups preserve upside.

This works only if the company succeeds and the stock price rises above the strike. If the company fails or stagnates, options issued at a high strike become worthless—the employee received nothing. RSUs, meanwhile, would have vested at whatever fair value was assigned and would retain some floor value (though often zero if the company fails).

Execution and secondary market risk

Options introduce execution friction that RSUs eliminate. When a startup is acquired or prepares for an initial public offering (IPO), option holders must decide whether to exercise their vested options before the liquidity event. If the strike is far below the acquisition price or IPO price, this is a cash outlay—exercising a 100,000-share option at a $2 strike costs $200,000, even if the stock is worth $50.

The employee might not have $200,000 in cash or might hesitate to pay that tax bill on options that are about to become liquid. Some acquirers or IPO underwriters will allow “net exercise” (paying the tax with shares rather than cash) or provide other mechanisms, but these are exceptions.

RSUs are frictionless: they simply vest as shares and can be sold immediately with no further action or cash required.

Additionally, in down markets or if a company’s trajectory falters, employees holding deep out-of-the-money options lose motivation and confidence—the promised upside evaporates. RSU holders still have vested shares to sell or hold, providing psychological and financial resilience.

When companies switched to RSUs

Large, public companies and well-funded late-stage startups (Series C and beyond) now predominantly use RSUs because the accounting burden is manageable, the cash flow is predictable, and employees expect familiar vesting mechanics. A $10 billion startup with multiple funding rounds and strong revenue can absorb the accounting expense and cash withholding.

But at the seed and Series A stages, options remain the norm because they preserve scarce cash and delay the dilution and accounting impact of large compensation grants.

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