Startup Equity Instruments
Explained Like You're Smart, Not a Lawyer
For US-based B2B founders (Angel → Series A): the basic equity building blocks every startup uses—and why mistakes here quietly explode later.
TL;DR
-
Startups issue equity in several forms: stock, options, restricted stock, warrants, and convertible securities like SAFEs and notes.
-
Each instrument behaves differently for ownership, control, taxes, and cap tables.
-
Most founder mistakes come from mixing these up or issuing them without the required approvals, documents, or valuations.
What Is Equity?
Shares / Stock
Definition: Shares (or "stock") represent ownership in a company.
-
"Stockholder" and "shareholder" mean the same thing
-
Delaware corporations (most startups) use "stockholder"
-
California often uses "shareholder"
-
Different classes of stock (e.g., Common Stock, Series A Preferred) have different rights, preferences, and privileges
-
Those differences live in the certificate of incorporation also known as the charter or articles of incorporation
Why this matters: Not all stock is created equal. Investors don't buy "ownership vibes"—they buy specific legal rights.
Stock Options
Definition: A stock option is the right to buy stock later at a fixed price.
-
Options are not stock
-
Option holders cannot vote and do not receive dividends
-
Stock only exists once the option is exercised
-
Exercising = paying the exercise price to buy shares
Why this matters: Founders regularly promise "equity" when they're actually granting nothing yet.
Value: Par Value vs Fair Market Value (FMV)
Par Value
-
The lowest legal price at which shares can be issued
-
Mostly a legal minimum, not economic reality
Fair Market Value (FMV)
The current value of one share.
For Options:
-
FMV must come from an independent 409A valuation
-
The 409A valuation must be less than one year old to comply with Section 409A of the tax code
-
Major events (like fundraising) can invalidate it
For Stock:
-
A 409A valuation is highly recommended to determine FMV
Why this matters: Incorrect FMV = tax problems for your team and red flags for investors.
Cap Table Basics
Definition: A capitalization table (cap table) records who owns what.
Fully Diluted Cap Table
Includes:
-
Issued stock
-
Options
-
Warrants
-
SAFEs
-
Convertible notes
Why this matters: Investors price risk using the fully diluted picture, not the "clean" version founders prefer.
Stock Plans & Equity Incentives
Definition: A Stock Plan (Equity Incentive Plan) allows a company to issue restricted stock or options to employees in compliance with tax and security laws.
Key requirements
-
Must comply with tax rules (e.g., Rule 701)
-
Reserves a fixed pool of shares
-
Must be approved by stockholders within one year of approval by the board
Why this matters: Issuing options outside a plan is one of the most common startup errors—and one of the most expensive to fix.
Vesting (Where Confusion Peaks)
What Vesting Means
For Stock:
-
The purchaser owns the stock immediately
-
The company can repurchase unvested shares at cost if the person leaves
For Options:
-
Vesting controls when the option can be exercised
-
No vesting = no exercisable option (unless the option is granted as an early exercise option)
Common Terms
-
Cliff: period where nothing vests
-
Vesting Schedule: timeline of vesting
-
Standard schedule: 4 years, 1-year cliff
-
Vesting commencement date: when vesting starts (must be before the grant date)
Exercising Options
-
Can exercise vested options while providing services
-
After leaving, typically 3 months to exercise
-
Unexercised options are canceled
-
Most options expire after 10 years
Why this matters: Miss an exercise window and equity disappears permanently.
Restricted Stock
Definition: Stock issued upfront with restrictions until vesting.
Key Features
-
Immediate ownership and voting rights
-
Company can repurchase unvested shares if the person leaves
-
Vested shares are fully owned
-
The issuer and holder of the stock may be subject to additional tax liabilities if the stock is issued below FMV
Why this matters: Restricted stock behaves very differently from options—especially on departure.
Warrants
Definition: Warrants are rights to buy stock later, similar to options.
Differences
-
Usually issued outside a stock plan
-
Often granted to entities (not employees)
-
Common in commercial agreements
Why this matters: Warrants still have the potential to dilute ownership and must be tracked.
Convertible Securities
SAFEs
-
Money now, equity later
-
Convert during a future financing
-
No stock until conversion
Convertible Notes
-
Debt that may convert into equity
-
Have repayment mechanics
Cap Table Treatment
-
Tracked
-
Not counted as issued stock until conversion
Why this matters: Ignoring convertibles makes your cap table fictional.
Required Compliance Steps (Non-Optional)
Equity can only be issued if all of the following are true:
Board Approval
-
Required before issuance
-
Grant date = board consent date
Share Availability
-
Stock: enough authorized shares
-
Options: enough plan-reserved shares
Options Require
-
An option plan
-
A valid 409A valuation (< 1 year old)
-
Signed option agreement
-
Signed exercise notice (when exercised)
Stock Requires
-
Board consent
-
Signed stock purchase agreement
-
Purchase price paid
Some states require securities registrations. This affects compliance—but not the cap table.
Why this matters: Unsigned, unpaid, or unapproved equity does not legally exist.
FAQ
Q: Are options equity?
A: No. They are a right to buy equity later.
Q: Can I issue equity without board approval?
A: No.
Q: Does unpaid stock count?
A: No.
Q: Do SAFEs dilute ownership today?
A: Economically yes, legally no—until conversion.
Bottom Line
Equity instruments look similar but behave very differently.
Most founder horror stories start with "we thought this was fine."
What To Do If You're Busy (or Normal)
We built Aegis to apply knowledge like this so busy founders don't have to.
*Account required
We're lawyers, remember? Please read this important note:
Story LLP is a law firm, and Story's lawyers built Aegis to deliver better, standard legal services at scale so founders can choose between elite specialized lawyers and standardized process automations that replicate those lawyers according to their needs and budget. By definition, a standardized process may not be perfect for you. Please review our Policies page to better understand the difference, as well as how we use AI and how we manage conflicts, privilege, etc.
As a law firm, we must screen clients for conflicts of interest, and we treat all correspondence with clients seeking legal advice as privileged and confidential to the maximum extent possible in consideration of any conflicts. However, Story's law firm or our Attorney Allies do not represent you or your company as your lawyer, do not have an attorney-client relationship with you or your company, and do not provide you with legal advice absent a formal Engagement Letter signed between you and the Story LLP law firm. Please don't confuse the free knowledge we offer on this site with legal advice for you.