Receiving Non-Qualified Stock Options (NSO) as Compensation for a Consulting or Startup Advisory Position
- Nisha Mehta, MD
- Oct 15
- 7 min read
Many doctors on our physician communities are interested in being advisors to startups in the healthcare space (which we feel is so necessary!). However, one question that often comes up is that of appropriate compensation. We cover the basics of various options in our dedicated article on being a physician startup advisor, but are digging in to more detail more specifically on non-qualified stock options, as many of the larger startups in the space seem to offer this to non-employee physicians helping advise or consult for their companies. Below, we’ll cover what a non-qualified stock option (NSO) is, how it’s different than incentive stock options or other equity arrangements, tax implications, and more.
Disclosure/Disclaimer: Our content is for generalized educational purposes. While we try to ensure it is accurate and updated, we cannot guarantee it. We are not formal financial, legal, or tax professionals and do not provide individualized advice specific to your situation. You should consult these as appropriate and/or do your own due diligence before making decisions based on this page. To learn more, visit our disclaimers and disclosures.
What is a non-qualified stock option (NSO)?
Startups and other companies generally offer two different types of stock options as equity to employees or contractors, incentive stock options (ISOs) and non-qualified stock options (NSOs). NSOs can be given to non-employees, which is why they are usually the form of equity given to consultants or advisory board members.
When you are granted an option, it is not the same as the company gifting or giving you stock. What an option does is give you the ability to buy a stock of the company at a predetermined fixed price that is equal to the fair market value of the stock on the day that you receive it, even if the price/value of the stock goes up later. This is known as the strike price.
There are also other equity types such as restricted stock awards (RSAs) and restricted stock units (RSUs), but we will focus on NSOs for the purpose of this article, as from what we’ve seen, most startup companies offering equity most offer tend to offer advisory board members and consultants this type of equity.Â
Like most equity situations, NSOs typically follow a vesting schedule, so you don’t get all of your potential options from the beginning. Each vesting schedule can look different, but typically you will slowly ‘vest’ into your total offered stock options over a defined period of time. For example, they may say that you get 1/24 of your shares monthly over a period of 2 years. Alternatively, you may have to stay with the company for a certain amount of time, and then get all the shares at once (and if you leave before that time, you get none).
What are the pros and cons of a NSO?
Benefits of NSOs
A big benefit of an NSO is its flexibility. The company can give NSOs to many different people, not just employees. It also doesn’t require you to own something potentially of value - which would have tax consequences - until you decide to claim it (exercise your options) because you know that it’s worth something. However, despite not owning it or having tax implications from the start, you get to benefit from the growth of the company, assuming that the company does well.
Best case scenario: If you get early stage NSOs, and a company ends up doing really well, you could feasibly see the value of your shares going from very little to a very substantial amount. So while you can pay for those shares at your pre-established strike price, let’s say for a few thousand dollars, you can then own shares worth hundreds of thousands of dollars (or even millions!).
Another benefit of NSOs as an advisor or consultants is that you can negotiate the terms, like the amount you get and the vesting schedule. The company may be more negotiable on these terms than a cash offer for compensation, because many startups don’t have a lot of extra money laying around, but they know that if the share values go up significantly, they likely won’t mind you getting more upside. Incentives are also aligned better than a fixed cash payment for your services, because everybody wins if the company does well.
Downsides of NSOs
The biggest downside of NSOs is the taxation, which we’ll discuss below. As an advisor that’s granted equity via NSOs, you’ll typically pay taxes at every step of the journey once you decide to exercise them and claim your stocks, even if you don’t sell them yet - whereas with an ISO, assuming there’s not an AMT issue (beyond the scope of this article), you likely won’t pay taxes until you sell.
The other big downside to NSOs is that unless you are able to sell them, there’s a fair amount of risk to exercising your options. You could exercise the options, pay taxes, and then the company could go belly up. There can also be lots of rules about when you can sell them and to whom. So overall, unless there’s a clear exit, this is a pretty illiquid asset that carries risk in owning. For this reason, many will choose not to exercise their options until they know they can sell their shares, and will do simultaneously.
Additionally, if you accept these as your sole compensation, know that the NSOs could have zero value if the startup doesn’t succeed, or if the company lets you go before you’ve vested into your shares.
Taxation of non-qualified stock options (NSOs)
When you are granted the NSOs, as we said before, there are no tax consequences until you exercise the shares.
Taxes on exercise of NSOs
However, when you exercise your shares, assuming that the fair market value (FMV)Â of the shares at the time of exercise is higher than your strike price when you were granted them, you will typically pay tax on the difference between your strike price and the FMV (known as the spread).Â
Since you are an advisor or consultant, and thus an independent contractor and not an employee, you will likely have to pay taxes directly to the IRS. This is unlike for employees of the company, for whom the company has the option of withholding the relevant taxes from your payroll if possible.
The taxes will be both income tax and payroll taxes (which are significant for self-employed income).
Note that if your shares have gone up a million dollars in value, this could mean that you are responsible for paying several hundreds of thousands of dollars in tax out of your pocket, even when you haven’t sold the shares yet. Make sure you talk to your accountant before exercising shares to understand the consequences of doing so.
Taxes on sale of shares after exercise
If you sell your shares at the same time that you exercise them, you won’t typically pay additional taxes - unless you’re able to sell them for more than the fair market value determined by the company’s latest 409A valuation. In this case, you’ll owe short term capital gains on the difference between the declared fair market value and the sales price.
However, if you don’t sell them at the time of exercise, that’s not all the taxes you’ll pay. After you exercise your shares and pay the ordinary income taxes on them, you may hold them for a while. If you do this and the shares continue to rise in value, when you sell your shares, you’ll have to pay capital gains tax on the appreciation.
If it’s been over a year since you exercised your shares, this will be long term capital gains tax. If it’s been less than a year since you exercised your shares, you’ll pay short term capital gains tax. As we explained on our primer on taxes, long term capital gains tax is at a lower rate than short term capital gains tax for most doctors.
One potential exception to this is if you hold your stock for five years or more. In this case, it may be eligible for the qualified small business stock (QSBS) tax benefit, which can allow you to exclude up to 100% of your capital gains from at least federal taxes depending on how you sell the stock. The details of this are beyond the scope of this article, and you should definitely talk to a tax professional for more details on how this applies to your situation.Â
Tips before accepting NSOs for compensation for your startup advisory position or consulting role
Understand what your shares are currently worth. To do this, you’ll want to ask for the most recent 409A valuation, which will tell you the current fair market value.
Understand the tax implications of NSOs. If necessary, discuss how these apply specifically to your tax strategy situation with your accountant or tax professional
Negotiate (as always!). You can ask for more NSOs, can ask for some cash to mitigate your risk, or you can edit your vesting schedule (shorten to 2 years from 3, get immediate vesting in a certain amount, etc.).
Make sure everything is in your contract and in writing, so that there’s no confusion, and have it reviewed by a lawyer. While something may seem like a few thousand dollars of value in the moment, in a best case scenario, it could turn into a large amount of money, and you don’t want somebody to then find a way to refuse to give you what you’re owed.
Conclusion
When considering how you want to be compensated for your startup advisory or consulting position, you may have the option of receiving equity. A very common offering is to receive NSOs. We hope this article helps you understand the value of those, as well as the tax implications, so that you can decide if this is an attractive option for you. As always, consult your tax professional before making any decisions, as these options can have massive tax implications!
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