Employee Equity in California: Options, RSUs, and the Traps

The instruments and who they suit

• Incentive stock options (ISOs) — employees only, potential capital gains treatment, subject to AMT and the $100,000 annual vesting limit.
• Non-qualified stock options (NSOs) — available to contractors and advisors, taxed as ordinary income on the spread at exercise.
• Restricted stock — early-stage grants with an 83(b) election filed within 30 days, which starts the capital gains clock at a low value.
• RSUs — no exercise cost and simpler for employees, but taxable at settlement, which is why later-stage companies use double-trigger vesting.
• Phantom equity or profit interests — useful in LLCs where actual equity would complicate the structure.

Valuation and the 409A problem

Options must be struck at no less than fair market value on the grant date. Private companies establish that through an independent 409A valuation, refreshed at least every twelve months and after any material event such as a financing round.

Granting below fair market value triggers section 409A penalties on the recipient — immediate income inclusion plus an additional 20% tax. The employee bears the consequence of the employer's process failure, which is exactly the kind of problem that becomes a claim.

Vesting, exercise windows, and departures

The standard remains four-year vesting with a one-year cliff and monthly vesting after. What varies, and what employees increasingly negotiate, is the post-termination exercise window. The default 90 days forces departing employees to pay the strike price and any tax at once, often on illiquid stock.

Extended windows of up to ten years solve that but convert ISOs to NSOs after 90 days. Acceleration terms also matter: single-trigger acceleration on a change of control is rare and disliked by acquirers; double-trigger — change of control plus termination — is the common negotiated position for executives.

Securities and California specifics

Equity grants are securities offerings needing an exemption. Rule 701 is the usual path for private company compensatory grants, with additional disclosure obligations once aggregate sales exceed the regulatory threshold in a twelve-month period. California has its own qualification requirement with a corresponding exemption for compensatory plans.

Document everything: a board-approved plan, board or committee approval of each grant, executed award agreements, and an accurate cap table. Diligence in a financing or sale will test all four, and reconstructing missing approvals under deal pressure is one of the more avoidable ways to lose leverage.

Where equity disputes come from

• Offer letters promising a percentage of the company rather than a share count against a stated fully diluted base.
• Grants promised verbally and never formally approved by the board.
• Repurchase rights on departure that the employee never understood.
• Failure to file an 83(b) election within 30 days of a restricted stock grant.
• Unclear treatment on an acquisition, particularly for unvested shares and options that are cashed out or assumed.