An offer letter promises equity. How does equity work in a startup? It is a slice of ownership, earned through vesting, diluted as new shares are issued, and turned into cash only on the terms attached to it.
Equity choices start at company formation, so it helps to read this alongside the broader guide on how to start a startup. The sections below take the most common misunderstandings in turn, from the founder’s side and the employee’s side.
Ownership and value are not the same thing
Startup equity is ownership in the company. Start-up India’s explainer compares it to slices of a pie and notes that the value of each piece increases as the business becomes more successful. Two questions follow: what percentage do you hold, and what is the company worth? A founder uses equity to reward the people who invest time, effort and money. An employee holds equity as pay that is worth more only if the company succeeds.
Three misunderstandings cause most of the confusion:
- “A percentage is a payout.” A percentage describes your slice, not the size of the pie. Company value and the rights attached to your shares decide what the slice is worth.
- “Equity is one thing.” The instrument depends on the holder. One startup accounting guide says investors usually receive preferred stock, advisors typically get advisory shares, and employees usually receive stock options.
- “Granted means owned.” A grant is a promise until it vests. The vesting section below shows how long that can take.
Common stock, preferred stock, options and RSUs compared
Each instrument gives a different bundle of rights, so two holders with the same percentage can sit in very different positions. The table sets the four main instruments side by side.
| Instrument | What it gives | Planning use |
|---|---|---|
| Common stock | The most basic form of stock, usually granted to founders, employees and early investors | Treat it as the base layer of ownership and check which holders rank ahead of it |
| Preferred stock | Priority over common shareholders when dividends are paid, and a claim to company assets in the event of bankruptcy | Read the preferred terms before trusting a percentage, because these rights sit above common holders |
| Stock options | The right to purchase a certain number of shares at a specified strike price | Ask for the strike price and the exercise terms, because an option is a right to buy, not a share already owned |
| RSUs | A fixed number of shares granted once certain conditions, such as vesting, are met | Confirm exactly which conditions trigger delivery of the shares |
Definitions of common and preferred stock follow Firstbase’s beginner guide, and the option and RSU definitions follow this venture capital equity guide.
When you compare offers, ask three things: is the grant common or preferred, is it options or RSUs, and what conditions apply before anything is yours? The answers change how the same headline percentage should be read. Founders should be equally explicit when granting equity, because vague terms are hard to repair after investors join.
Early allocation: founders, advisors, employees and the option pool
Early equity goes to the people who put something into the company. Start-up India says the people who invest time, effort and money are the ones who receive it, and later funding rounds such as Series A, B and C often involve a transfer of equity to the stakeholders in those rounds. The same guidance lists the usual early recipients:
- Co-founders: they split the equity between them according to what each contributes. Founders still shaping an unproven product can use the Minimum Viable Product Checklist: Build Faster, Test Smarter In 2026 – Startalliance to agree what counts as contribution before numbers are written down.
- Friends, family and early investors: they receive equity in return for money they put in.
- Advisors and industry experts: they are often compensated with equity for their services.
- Employees: they typically receive equity from a pool of shares reserved for hiring.
Shares belong to a legal entity, so settling the company’s identity comes first; the Startup Name Ideas: 50 Creative, Memorable Options And How To Choose The Right One In 2026 – Startalliance guide covers that step.
The employee pool is where most hiring grants come from. The same accounting guide notes that most VC-backed startups give employees stock options, which is called the option pool. Firstbase recommends setting aside 10-20% of company shares for employee equity, and describes 10 to 15% as typical for an employee option pool. Treat these as planning guidance for sizing a pool, not as a rule or a cap. A smaller team with few planned hires may need less, and a team planning many senior hires may need more.
Vesting and the one-year cliff
Vesting is the schedule on which a grant becomes earned ownership. The common startup structure, according to a venture capital equity guide, is a 4-year schedule with a 1-year cliff. A startup accounting guide puts the effect plainly: equity usually vests over 4 years, so you usually receive nothing in the first year.
A practical explainer on equity packages shows how the cliff works in a standard grant:
- Before the cliff: nothing vests, so leaving early means leaving with no equity from that grant.
- At the cliff: a quarter of the equity vests on the one-year anniversary.
- After the cliff: the rest vests monthly over 3 years.
Some grants skip the monthly step. The venture guide gives an example in which 25% of an employee’s equity vests each year across a 4-year schedule. Check which pattern your grant uses, because it decides when the next slice becomes yours.
Vesting is not only an employee mechanism. Firstbase advises co-founders to paper their own equity with a four-year vesting schedule and a one-year cliff. Founders who skip this leave their ownership unprotected if a co-founder departs early, and the plain fix is the same schedule that employees receive.
Dilution and the cap table
A cap table records who owns the company at any point in time, including founders, investors and employees, and it also shows future rights such as the option pool, according to the startup accounting guide. It is the document that turns a vague offer into something checkable. Ask for a current snapshot before you accept a grant, and keep a live copy if you are a founder.
Dilution is the reason the cap table keeps changing. New funding rounds issue new shares, so each existing holder’s percentage falls. The equity-package explainer gives an illustrative case: after a Series A, a 0.5% stake falls to about 0.425% following a 15% dilution, and that stake is worth $127,500 at a $30M post-money valuation. The percentage dropped, yet the stake can still carry real value when the company’s valuation is high enough. This ties back to Start-up India’s point that each slice grows in value as the business succeeds.
So read dilution as a trade: a smaller share of a more valuable company. It becomes a problem when the percentage falls and the valuation does not rise to compensate. Track both your share count and your percentage, and expect each new round to move the percentage.
How equity becomes cash
Equity is worth cash only when its value can be realised, and the instrument decides the steps. For options, you must buy the shares at the strike price, and timing matters after you leave. The equity-package explainer says most companies give you 90 days to exercise after leaving, and that US incentive stock option (ISO) grants follow a 3-month exercise period after exit. A departing employee should therefore plan the purchase cost before the last day, not after it.
RSUs work differently. They grant a fixed number of shares once conditions such as vesting are met, so the question is which conditions apply rather than whether you can afford to exercise. In a poor outcome, rank also matters. Preferred shareholders have a claim to the company’s assets in the event of bankruptcy, according to Firstbase, so common holders should not assume their percentage equals their share of the proceeds.
Tax treatment differs by instrument and by country, so confirm it with a qualified adviser before exercising options or accepting delivery of shares.
Frequently asked questions
| Question | Answer |
|---|---|
| Can a sole founder keep all the equity? | Yes. Start-up India says a sole founder keeps 100% of the equity until later rounds or grants transfer some of it to others. |
| How much equity do employees usually receive? | It depends on the role. One startup accounting guide puts employee equity in a range from 0% to 6%. |
| Are options or shares better for an employee? | It depends on how sure the value is. Firstbase says options can be attractive if you are unsure about future value, while actual shares grant immediate ownership. |
| What does equity look like in an LLC or partnership? | The form changes with the entity. The same guide says corporations use shares or options, LLCs use membership units, and partnerships use partnership interests. |
