Basics of Founder Compensation (Part I): A Guide to “Founder Stock”
Most startup founders will spend months agonizing over their product roadmap, customer acquisition strategy, and fundraising pitch. But when it comes to their own equity, often their single largest potential asset, many make critical decisions in a matter of hours, or worse, treat it as an afterthought.
The cost of getting founder compensation wrong can be staggering. A delayed equity grant can trigger tens of thousands of dollars in unnecessary taxes. A missed 83(b) election can create a tax bill that exceeds a founder’s liquid net worth. Poor vesting terms can leave a departing co-founder with an outsized stake while the remaining team struggles to recruit replacements.
This post is the first in a series on founder compensation, starting with the most critical decisions on day 1: timing and structure of initial equity grants.
Timing Is Everything in Founder Equity
The moment a company is incorporated, a clock starts ticking. Under IRS rules, at any point in time at which stock is granted, a company's stock has a "fair market value" (FMV) that must be determined for tax purposes. At the time of formation, in most cases that value is essentially zero. As a company gains traction, hits development milestones, and raises capital, the FMV of its stock climbs.
At incorporation, there is usually a brief window when stock can be issued at par value (the nominal value assigned to each share, often $0.0001 or $0.00001) with minimal tax consequences. Missing this window may require a founder to pay significantly more in taxes or cause the founder to receive stock options instead of owning the stock outright (which can be meaningfully different in both tax treatment and control rights).
For example, if a founder is granted 1 million shares at formation, when the FMV is $0.0001 per share, the founder must pay tax on $100 of income (assuming an 83(b) election is properly filed). However, if the stock is granted 12 months later, after the company has built an MVP or raised capital from investors, that same equity might have an FMV of $0.05 per share, meaning the founder would pay taxes on $50,000 of income.
The guiding concept is that equity is cheapest at formation.
The Basics of “Founder Stock”
What Type of Equity?
When equity is issued immediately after formation, founders typically receive common stock (as opposed to stock options or restricted stock units (RSUs)). This is driven by a variety of factors, including:
Ownership and control: Common stock gives founders voting rights from day one. Stock options, by contrast, do not confer voting rights until they are exercised.
Capital gains treatment: If common stock is held for more than one year, the gain recognized when the shares are eventually sold will be taxed at long-term capital gains rates (currently a maximum 20% federal rate vs. up to 37% for ordinary income).
QSBS: Assuming the company is otherwise eligible, common stock held for the required period (ranging from three to five years) may qualify for Qualified Small Business Stock treatment, as discussed further below.
How Much Equity?
This is a fact-specific question with no universal answer, but founders typically receive 80-100% of the initial equity, with the remainder (if any) reserved for an equity incentive pool. How that founder allocation is divided depends on the number of founders:
Solo founder: Gets the full founder allocation (80-100%). Solo founders sometimes reserve a larger equity pool (e.g., 15-20% or more) to preserve flexibility for bringing on a co-founder later or making large early grants to key team members.
Two co-founders: Split the founder allocation between them. A 50/50 split is possible, but less common. Most teams adjust the split based on factors like role, expertise, time commitment, and initial capital contribution (for example, 60/40 or 55/45).
Three or more co-founders: Divide the founder allocation among the team, often with unequal tiers that reflect each founder's contribution and role (for example, 47%/33%/20% for a three-founder team, or 40%/30%/20%/10% for four founders).
When evaluating these initial grants, founders should keep in mind that venture-backed companies typically experience roughly 20-25% dilution in each priced financing round.
Founders should also consider whether to create an equity incentive pool at formation, and if so, how large it should be. If the company anticipates granting options to key hires or advisors in the near term, having a pool already established can simplify the process of making those grants.
For sizing, founders should ask: how much equity will the company need before the next financing round? Since pools can be resized later, there's no need to create a large pool for long-term needs, and doing so may cause unnecessary dilution. The focus should be on what will actually be needed in the short term.
Should Equity Vest Over Time?
Founder grants usually have vesting conditions, which is good governance for the company and demonstrates commitment to current and future shareholders. Vesting ensures that founders earn their equity over time. It protects:
Co-founders: If one founder leaves after three months, standard vesting can help ensure they do not walk away with 40% of the company.
Investors: Many VCs hesitate to invest in a company where founders can leave with all their equity and will push for vesting terms.
For venture-backed companies, equity is typically issued subject to 4-year vesting with a 1-year cliff, meaning that the founder's equity becomes fully theirs over 48 months, but nothing vests until they have hit the "cliff" after the first 12 months (at which point the first 25% vests all at once, with the remaining 75% vesting in equal monthly installments over the next 36 months).
If a founder leaves before their equity fully vests, they keep their vested shares, but the company has the right to repurchase any unvested shares at the original purchase price (often par value, like $0.0001 per share).
When Should Vesting Accelerate?
Vesting acceleration allows a founder's unvested equity to vest immediately (or on an accelerated schedule) when certain events occur. There are two common formulations:
Single-Trigger Acceleration: A founder's unvested equity vests immediately upon a single event, typically a change of control (like a merger or sale of the company). If the company is acquired after 2 years and 50% of the founder’s equity remains unvested, single-trigger acceleration means the founder would vest into 100% at closing. Note that many investors strongly resist single-trigger acceleration because of the increased risk of founders cashing out and leaving immediately after an acquisition.
Double-Trigger Acceleration: A founder's unvested equity vests only if two events occur: (1) a change of control, and (2) the founder is terminated without cause or resigns for good reason within a specified period (often 12 months) after the change of control. This is usually more palatable to investors because it balances founder protection with investor interests. The founder is protected if they are pushed out after an acquisition but is less likely to voluntarily leave right after the deal closes.
Founders can negotiate for full acceleration, where 100% of unvested shares vest upon the trigger events, or partial acceleration, where only a portion (for example, 50%) vests upon the trigger events. Partial acceleration can be an acceptable compromise with investors who resist full acceleration.
What is an 83(b) Election?
A founder who receives stock subject to vesting and who is subject to U.S. taxation (or who foresees the possibility of becoming a U.S. taxpayer in the future) must file an 83(b) election with the IRS within 30 days of receiving the stock.
An 83(b) election allows the founder to pay tax on the value of the stock at grant, when it’s worth almost nothing, rather than as it vests over time. This matters because without the election, the founder owes ordinary income tax each time shares vest. The taxable amount is the spread between the fair market value at vesting and the amount paid for the shares at grant (often just par value). As the company grows and valuations increase, this spread widens dramatically, creating massive tax bills on "phantom income" (i.e., income the founder hasn’t actually received in cash and may have no ability to pay).
The math is stark: A founder who files an 83(b) election on 1 million shares granted at $0.0001 per share pays tax on $100. A founder who doesn't file the election and whose shares are worth $0.50 when they vest would owe tax on $500,000 of income over the vesting period, putting the founder potentially on the hook for a six-figure tax bill with no cash to pay it.
The 30-day deadline is absolute; the IRS does not make exceptions or grant extensions. This is one of the most important tax filings a founder will make.
Quick Note on QSBS Treatment
If a company meets certain IRS requirements, the shares a founder receives at formation may qualify as “qualified small business stock,” or QSBS. That can be a major long-term tax benefit: if the company meets the rules and a founder holds their shares long enough, the founder may be able to exclude up to $15 million of gain (or 10x basis, if greater) when the shares are sold (or up to $10 million for stock issued prior to July 4, 2025).
For stock issued before July 4, 2025, the gain may be excluded if the shares are held for at least five years. Under the new rules for stock issued after July 4, 2025, holding periods are now phased: 50% of the gain may be excluded after three years, 75% after four years, and 100% after five years.
The main requirements include that the company was a U.S. C-Corporation when the stock was issued; its aggregate gross assets at the time the stock was issued (and immediately after) did not exceed $75 million; its business qualifies under the active-business rules; and the shares were acquired directly from the company (not on the secondary market).
Getting the structure right from day one and maintaining clean records is essential to preserve the option to claim QSBS benefits.
Practical Takeaways and Action Items
The equity decisions founders make in their company's first few weeks can determine whether they actually capture the value they're building. While the tax rules and structural considerations are complex, the underlying principle is straightforward: get the basics right early, when equity is cheap and the stakes are clear.
✓ Issue founder stock at formation or immediately afterward. The tax savings can be significant, and the window is often brief.
✓ File 83(b) elections within 30 days of any stock grant with a vesting condition. Set multiple calendar reminders. Ask your lawyer to remind you. This is critical, and a costly place for a mistake.
✓ Implement a vesting schedule. Standard 4-year vesting with a 1-year cliff protects the company and is expected by investors.
✓ Document everything properly. Board resolutions, stock purchase agreements, and updated cap tables are essential.
✓ Standardize acceleration provisions before taking investor money. Once investors are at the table, leverage shifts. Build any desired acceleration terms into the company's initial documents.
✓ Consult with a tax advisor on your personal situation. Everyone's tax situation is different. Founders should get personalized advice, especially for large grants.
✓ Review and update equity arrangements as the company grows. What made sense at formation may need adjustment as you add co-founders, raise capital, or hit major milestones.
References and Sources:
Internal Revenue Code (IRC) §1202 regarding Qualified Small Business Stock rules and guidance on 2025 QSBS phased exclusion
IRC §83(b) of 26 U.S.C. § 83(b) regarding election to include value in gross income in year of stock transfer, IRS Publication 525
IRS Regulations (e.g., IRS Reg. §1.409A-1(b)(5)), Publication 525
Federal long-term capital gains rates (e.g., 26 U.S.C. § 1(h))