I am a new "key employee" (VP level) with a startup biotechnogy company. In the letter of offer the company is awarding stock options. Is it better to get RSUs or regular stock awards or both at employment? Advantages versus disadvantages please? Thank you
A startup tends to offer a few different types of equity compensation depending on size.
The company would offer stock options (either Incentive Stock Options and Nonqualified Stock Options). They are allowed to give $100K of ISOs per year. (Note, if you have early exercise privileges, then only the first $100K worth of shares would be ISOs and the rest would automatically convert into NSOs). Stock options are an attractive way of granting equity for startups because they are very employee friendly. If the company isn't doing very well, the employees can walk away from the options. If the company is doing well, they can exercise and buy into the company (which benefits from the extra cash). ISOs (Incentive Stock Options) are very beneficial because you don't have to pay tax when you exercise them. If the spread between the strike price and the fair market value of common shares (or known as 409a price) is too high, then you may be on the hook for a lot of AMT tax. This is usually the case if the company somehow 40x in a year (in the case of Uber). NSOs require taxes to be withheld by the company at exercise. They are taxed at ordinary income tax rates.
When the company is very young, they tend to offer founder stock and stock options. The strike price tends to be very low (10 cents or something less) and usually the early employees file a Form 83b election (if there is vesting). The Form 83b tells the IRS you intend to purchase all of the shares at the current strike price/fair market value thus locking in your tax cost basis to the current strike price. If you don't file the form 83b (within 30 days of receiving the shares), you may end up having to pay taxes as the shares vest. If the stock price rises, then you may be liable for Alternative Minimum Tax (AMT).
After a point, options may become too expensive for employees (when the value has risen quite a bit). At that point, startups tend to start issuing Restricted Stock Units. RSUs are less tax friendly as they are phantom shares and would never be eligible for long term capital gains until they turn into real shares. As a result, RSUs are usually taxed at ordinary income tax rates. However, the good part of RSUs is you don't need to spend any money to buy them.