ISO vs NSO vs RSU: a plain-English primer
Almost all startup equity comes in one of three forms. They can be worth the same on paper and very different after tax. Here's what each one actually means.
The one-sentence version
- ISO (Incentive stock options): The right to buy shares at a fixed strike price, with tax advantages if you hold long enough.
- NSO (Non-qualified stock options): The same right to buy at a strike price, but without the special tax treatment.
- RSU (Restricted stock units): A promise of actual shares, delivered as they vest. There's nothing to buy.
Side by side
| ISO | NSO | RSU | |
|---|---|---|---|
| What you pay | The strike price for each share, when you exercise. | The strike price for each share, when you exercise. | Nothing. |
| When you're taxed | No regular income tax at exercise, but the spread can trigger AMT. Hold 2 years from grant and 1 year from exercise and the whole gain is taxed at long-term capital gains rates. | The spread between the current 409A and your strike is taxed as ordinary income when you exercise. Growth after that is a capital gain when you sell. | The full value is taxed as ordinary income when shares are delivered. At private companies that's usually at IPO or acquisition (“double-trigger”). |
| Common for | Employees only. Common at early and growth-stage startups. | Anyone. Contractors, advisors, and board members can only get NSOs. | Later-stage and public companies, where the shares already have clear value. |
| Watch out for | AMT on paper gains, and the usual 90-day window to exercise after you leave. | Income tax at exercise, on shares you may not be able to sell yet. | Tax withholding is often less than what you'll actually owe. |
Options vs. RSUs: the real difference
Options (ISOs and NSOs) are the right to buy shares at a fixed price, your strike price. They're only worth something if the company's shares end up worth more than that. If the company sells for less than what investors are owed, or shuts down, options can be worth nothing, and if you paid to exercise, you lose that money.
RSUs are shares themselves, delivered as they vest. There's no strike to pay, so they're worth something at almost any positive exit, as long as it covers what investors are owed first. That's why larger, later-stage companies tend to grant RSUs and early-stage companies grant options: an early grant of options at a low strike has more upside.
ISO vs. NSO: same thing, different tax
ISOs and NSOs work the same way economically. The difference is tax. NSOs are taxed as income on the spread when you exercise. ISOs aren't, but can trigger the alternative minimum tax, and they get long-term capital gains treatment on the whole gain if you hold long enough. We go deeper in ISO vs NSO.
Vesting applies to all three
Whatever the type, you usually earn it over time. The most common schedule is four years with a one-year cliff: nothing for the first year, then 25% at once, then the rest monthly. Leave before the cliff and you get nothing; leave later and you keep what has vested (for options, as long as you exercise within your plan's window, often 90 days).
The numbers that matter more than the type
The type decides how you're taxed. What you're likely to get is decided by your ownership percentage (your shares divided by the fully diluted share count), how much investors are owed first, and how much more the company raises before it exits. The calculator below models all three, whatever type you have.
Educational purposes only. Not financial, tax, or legal advice.