We’re often asked what the “critical” or “most important” legal advice is when issuing equity to service providers. The truth is, there’s no single answer—several key considerations matter equally. Below is a brief guide to the most important aspects, based on our experience.
When issuing equity to service providers, one of the most critical considerations is obtaining a 409A valuation. A 409A is an independent appraisal of your company’s fair market value (FMV) and provides a defensible basis for setting the price of stock or stock options. While not legally required to issue equity, a 409A valuation is essential for minimizing tax and legal risks—especially with stock options, where failure to price options correctly can trigger immediate income tax, steep penalties, and interest charges for recipients.
Issuing equity without a 409A valuation is particularly risky once your company has raised outside capital, generated revenue, or made significant progress, as these milestones suggest a higher valuation. For options, a 409A is must-have. For stock issuances, it’s still important to demonstrate a good-faith valuation, even if a 409A isn’t obtained.
Overall, a 409A valuation is a small upfront cost that provides significant protection, especially during future fundraising. For more detail, refer to this blogpost.
Whenever you’re considering issuing equity to service providers, you must ensure that a written agreement formalizing their relationship with the company is in place. This could be an employment agreement, a consulting agreement, or an advisor agreement—but it should be properly documented and signed by both parties.
This is important for several reasons, including ensuring that the service provider is bound by confidentiality obligations and that all intellectual property created in the course of providing services is properly assigned to the company.
Additionally, the service agreement typically sets out the promise of an equity award—its size and terms—which protects the company from potential future claims by service providers seeking disproportionately large stakes. To avoid disputes over how much equity is owed, it’s best to specify a fixed number of shares rather than referring to a percentage of the company’s equity.
An Equity Incentive Plan (EIP) is a formal plan adopted by a company to grant equity (such as stock options or restricted stock) to employees, contractors, advisors, and other service providers. The EIP helps keep the cap table organized, supports tax and legal compliance, and enables scalable equity granting as the company grows.
One of the main reasons why the EIP matters is Rule 701. This is a key SEC exemption allowing private companies to issue equity to service providers without registering the securities — provided the grants are made under a written and approved plan like the EIP. Relying on Rule 701 helps avoid burdensome registration requirements while ensuring compliance with securities laws.
To set up the EIP in your company, you’ll need both Board and stockholder consents approving the number of shares to be reserved, a document summarizing the terms of the plan, and the applicable form documents for future use.
If you're granting equity to service providers based in California, you'll also need to comply with California state securities laws. Most companies rely on the Section 25102(o) exemption, which requires a simple notice filing with the California Department of Financial Protection and Innovation (DFPI). This filing must be submitted within 30 days of the grant and helps ensure your company stays compliant at the state level.
Each equity grant must be individually approved by the Board. Approving the EIP alone—or entering a grant into Carta or Pulley—is not enough.
The Board Consent should specify the name of each purchaser, the number of shares issued to them, and the plan under which the grant is being made. If the shares are subject to vesting and acceleration (see below), the Board Consent should also outline the applicable vesting schedule and acceleration terms.
It’s important to keep in mind that the date of Board approval is usually considered the official grant date for tax purposes. This date starts the 30-day deadline to file an 83(b) election with the IRS. If the election isn’t filed within that window, the recipient may lose the potential tax benefits of early filing—like minimizing ordinary income and starting the capital gains holding period sooner.
In our other blogposts, you can find more information on how 83(b) elections work, what to do if the deadline is missed, and whether a filing is necessary if the purchaser is not a U.S. resident.
Not all grants are the same. The first decision a company needs to make is whether to grant restricted stock or stock options.
With restricted stock, the recipient becomes a shareholder immediately, gaining all associated rights, including voting. The recipient must also pay for the shares upfront. If the 409A valuation is high, the cost can be significant and potentially unaffordable. Even if the company offers a loan to cover the purchase, the value may still be treated as taxable income. As a result, issuing restricted stock is usually only advisable when the company is very early-stage, with little or no outside funding or revenue.
Stock options are different. You don’t become a shareholder — or pay anything — until you choose to exercise the option. This means no upfront cost, no company loans, and no tax consequences until exercise. Cons? No shareholder rights until the exercise.
If the company decides to grant stock options, the next step is choosing between Non-Qualified Stock Options (NSOs) and Incentive Stock Options (ISOs).
ISOs are only available to employees and come with favorable tax treatment — if certain conditions are met (like holding the shares for more than one year after exercise and two years after the grant), gains may be taxed at long-term capital gains rates instead of ordinary income. However, ISOs might be subject to the Alternative Minimum Tax (AMT), which can be complex to manage.
NSOs, on the other hand, can be granted to anyone — including contractors, advisors, and board members — but they’re taxed as ordinary income at the time of exercise on the spread between the strike price and fair market value.
In short: use ISOs for employees when possible, especially early on. Use NSOs for non-employees or when more flexibility is needed.
Deciding on the vesting schedule is a key part of issuing equity to service providers. Vesting means a stockholder earns ownership of their shares over time, following a set schedule.
There are two main types of vesting: time-based and milestone-based. Time-based vesting means shares vest over a fixed period—usually four years with a one-year cliff for employees and consultants, or two years for advisors—regardless of performance. Milestone-based vesting ties ownership to specific achievements, like delivering an MVP or reaching a certain ARR.
In both cases, vesting stops when the service provider leaves, unless the company chooses to accelerate some or all of the grant. Pro tip: include a signed Stock Power when entering into the Stock Purchase Agreement. If it’s not signed upfront, it may be difficult to get it later—especially if the relationship ends on bad terms.
Can a company skip vesting and issue fully vested shares upfront? Yes—but this comes with the risk that the person could walk away with the full grant shortly after joining.
Acceleration refers to the early vesting of unvested shares, typically triggered by specific events.
There are two common types of acceleration: single-trigger and double-trigger.
Employees and consultants typically do not receive acceleration, unless it's specifically negotiated. Most standard equity grants don’t include it.
Pro tip: Be intentional about including—or excluding—acceleration. It can significantly impact outcomes in an exit scenario and should align with the person’s role and leverage during negotiations. If you want acceleration for a certain service provider, make sure it’s mentioned in the Board consent approving the grant!
Issuing equity to service providers can be one of the most powerful tools for attracting and retaining talent—but only if it’s done thoughtfully and in compliance with legal and tax requirements. From obtaining a 409A valuation to structuring vesting and acceleration terms, each step plays a crucial role in protecting both the company and the recipient.
There’s no one-size-fits-all answer, but with the right legal documentation, clear communication, and strategic planning, equity grants can become a strong foundation for long-term collaboration and growth.
If you're not sure where to start or want a second set of eyes on your equity documents, feel free to reach out—we’re here to help.
Download a free, practical, founder-friendly equity issuance checklist and find our affordable legal packages for startups here.
