In the startup world, it can feel like everyone’s carrying employee stock options (ESOs) around in their back pocket. But are they something you need to put on the table?
A compelling equity package can do a lot of good for your venture, especially when you’re trying to give your rocket ship a shot at liftoff. So, here’s a look at four of the biggest benefits to offering a stellar employee stock option plan.
What are employee stock options?
Before we get into the benefits, let’s make sure we’re on the same page about what exactly we’re talking about when we talk about employee stock options.
ESOs are a form of equity compensation, which is often offered as part of a larger total compensation package. They give employees the right to buy company stock at a set exercise price (also called the strike price), starting on the grant date when the option is awarded. Most options come with a vesting schedule—often a one-year cliff before any shares vest, followed by monthly or quarterly vesting after that—and an expiration date, typically 10 years out, after which unexercised options disappear.
There are two main types of ESOs. The difference between them ultimately comes down to tax treatment.
Incentive stock options (ISOs) offer more favorable tax treatment for qualifying employees, but only if certain holding periods are met. Hold the shares long enough after exercising, and the gain is taxed at capital gains rates instead of ordinary income. However, the spread between the exercise price and the stock's fair market value at exercise can trigger the alternative minimum tax (AMT).
Non-qualified stock options (NSOs) are simpler but less tax-advantaged. The spread is taxed as ordinary income at exercise, no matter how long the shares are held afterward.
Stock options are different from an employee stock purchase plan (ESPP), which lets employees buy company stock at a discounted price through payroll deductions, without the vesting mechanics.
For many employees, the real payoff comes at an IPO, acquisition, or tender offer when shares finally become sellable. Phew. Now that we have that out of the way, let’s go over the benefits of offering ESOs.
The benefits of offering employee stock options
There’s a lot to sort out if you’re thinking of offering employee stock options, but the benefits often make it worth it. Here’s what you can look forward to when ESOs are on the table:
1. They help you compete for top talent
The best talent can work anywhere, and these days it takes more than a big paycheck to get them in the door. Employees take a chance when they decide to work for a startup, and ESOs help balance that out: With that risk comes a potentially big reward.
The opportunity to own a piece of what they’re helping to build is also something many employees want. The 2026 Morgan Stanley at Work State of the Workplace Financial Benefits Study found that 75% of employees and 85% of HR leaders say equity compensation is the best tool to effectively motivate employees, and 86% of employees who don't currently have equity say they'd like to have it.
2. They make your best performers want to stay
Startup life isn’t a quick ride to the top: It’s a long haul, and you want to keep the best beside you for the journey. Simply put, shared equity increases employee retention.
By granting stock options that vest over time, you can entice employees to grow with your business rather than jumping off to pursue the next challenge. You can also roll ESOs into performance incentives and promotions.
3. They encourage an ownership mentality
“We realized that while company founders are owners, more importantly, so is the team,” says Josh Reeves, Gusto’s CEO. “Igniting a true sense of ownership—the type that rallies the whole team around a single mission—starts with one’s equity stake in the company.”
How you structure your employee equity can meaningfully impact company culture. A Morgan Stanley at Work survey found that 56% of stock plan participants say their equity is a reason they continue working for their company. Give people a genuine stake in the outcome, and they start acting like owners.
4. They keep money in the bank
Being a startup doesn’t mean you’re broke. But if you don’t have the cash flow to offer market-rate salaries just yet, ESOs can help you compete without the need to hit the bank upfront.
Create an equity package that’s right for your business
Because granting equity is so darn complicated, founders often go with the cookie-cutter set-ups already out there. While there are certain advantages to the standard equity structures (you can get ready-made legal documents from your legal advisors) many entrepreneurs suggest creating one that jives with your business values. Whatever structure you choose, make sure you’re able to explain it clearly to your employees.
“Whenever we’ve done financing, or whenever I’ve made offers here for candidates to join and I dove into a lot of the detail, I didn’t agree with a lot of the ‘standard terms,’” says Reeves. “We created our own equity structure that makes sense for our future.”
The best ESO strategy should be in sync with your unique company philosophy, striking a balance that ensures your team feels valued, motivated, and inspired to do incredible work.
FAQs
Is an Employee Stock Option Plan different from an Employee Stock Ownership Plan?
Yes, despite the similar names, these are quite different.
An Employee Stock Ownership Plan (ESOP) is a qualified retirement plan, much like a 401(k). The employer contributes company stock (or cash to buy stock) into an account for each employee, which is regulated by ERISA. ESOPs are often used for succession planning, letting an owner transition the business to employees over time. Employees don't pay to participate in an ESOP. Instead, they build ownership value and typically cash out their shares when they leave or retire.
An Employee Stock Option Plan is a compensation tool, not a retirement plan. It gives employees the right to buy company stock at a fixed price after a vesting period. It's common at startups looking to attract talent with equity instead of (or alongside) higher pay. Employees have to exercise the option—actually purchase the shares—and take on the investment risk, since the payoff depends on where the stock price lands.
Is an employee stock purchase plan (ESPP) the same as stock options?
No. An ESPP lets employees buy company stock at a discounted price, usually through payroll deductions over a set offering period. Unlike stock options, there's no exercise price to lock in years in advance and no vesting schedule to wait out. Employees buy shares directly, at a discount, on a set purchase date. Both give employees a stake in the company, but they're separate programs with different mechanics.
What's the difference between incentive stock options (ISOs) and non-qualified stock options (NSOs)?
The main difference is tax treatment. ISOs can qualify for lower, capital-gains tax rates, but only for employees (not contractors or board members) and only if specific holding-period requirements are met after exercise. The tradeoff: exercising a large batch of ISOs can trigger the alternative minimum tax (AMT), a separate tax calculation that catches some employees off guard. NSOs are more straightforward: the spread between the exercise price and fair market value is taxed as ordinary income right when the options are exercised, regardless of how long the shares are held afterward.
What happens to unvested stock options if an employee leaves the company?
They're typically forfeited. That's the purpose of a vesting schedule—often starting with a one-year cliff—which rewards employees for staying. Options that have already vested usually stay with the employee, but there's commonly a limited window (often 90 days) after departure to exercise them before the expiration date kicks in.
Quick note: This is not to be taken as tax, legal, benefits, financial, or HR advice. Since rules and regulations change over time and can vary by location, consult a lawyer or HR expert for specific guidance.
