Equity Compensation 101: Stock Options, RSUs, and ESPP

## Why Equity Matters

At top tech companies, equity can represent 30-60% of total compensation for senior employees. Understanding how it works is essential for maximizing your earnings.

## RSUs (Restricted Stock Units)

### How They Work

1. Company grants you N shares, subject to vesting.
2. Shares vest on a schedule (typically 4 years).
3. At vesting, shares are delivered and you owe income tax.
4. After vesting, you own the shares outright.

### Common Vesting Schedules

| Company Style | Year 1 | Year 2 | Year 3 | Year 4 |
|---------------|--------|--------|--------|--------|
| Standard (most) | 25% | 25% | 25% | 25% |
| Amazon (back-loaded) | 5% | 15% | 40% | 40% |
| Monthly after cliff | 0% (12mo), then monthly | | | |

### Example

You receive 1,000 RSUs when the stock price is $150.
- Total grant value: $150,000.
- Annual vest (standard): 250 shares/year = $37,500/year at grant price.
- If stock rises to $200: annual vest = $50,000.
- If stock drops to $100: annual vest = $25,000.

## Stock Options

### ISOs vs NSOs

| Feature | ISO | NSO |
|---------|-----|-----|
| Available to | Employees only | Anyone |
| Tax at exercise | AMT only | Ordinary income |
| Long-term gains | If held 2yr+1yr | On gain above FMV at exercise |
| $100K limit | Yes (per year) | No |

### Key Decisions

1. **When to exercise**: Balance tax impact vs stock price appreciation.
2. **How many to exercise**: Model AMT scenarios for ISOs.
3. **When to sell**: After qualifying holding period for best tax treatment.
4. **Cash requirements**: You need cash to exercise (strike x shares).

## ESPP (Employee Stock Purchase Plan)

### Standard Terms (Section 423)

- Contribute 1-15% of salary via payroll deduction.
- 6-month purchase periods.
- 15% discount on the lower of grant date or purchase date price.
- Maximum $25,000/year in stock (at grant date FMV).

### ESPP Return Analysis

| Scenario | Stock Change | Return on Investment |
|----------|-------------|---------------------|
| Stock flat | 0% | 17.6% (from discount) |
| Stock up 20% | +20% | 41.2% |
| Stock down 10% | -10% | 5.9% |
| Stock down 15% | -15% | 0% (break-even) |

Even with a 10% stock decline, you still profit due to the discount.

## Managing Concentration Risk

If equity forms a large part of your net worth, you face concentration risk:

### Diversification Rules of Thumb

- No single stock should be more than 10-15% of your portfolio.
- Sell RSUs at vest and diversify (unless you have specific conviction).
- Use the "sell enough to diversify, keep the rest" approach.
- Consider tax implications before selling (holding period for capital gains).

### Tax-Efficient Diversification

- Sell shares with the highest cost basis first (minimize gain).
- Offset gains with tax-loss harvesting in other positions.
- Donate appreciated shares to charity (avoid capital gains + get deduction).

## Key Takeaways

1. RSUs are simpler and retain value even if the stock drops.
2. Stock options offer higher upside but can expire worthless.
3. ESPP is almost always worth participating in (15%+ guaranteed return).
4. Diversify — don't let company stock dominate your portfolio.
5. Understand the tax implications before exercising or selling.