RSUs vs PSUs: Comparing Equity Compensation

To attract and retain talented workers, several startups now include shares of ownership in their remuneration packages. Stock ownership in a firm may be lucrative, but before accepting an equity offer, you should do your research. The value of the stock in question as of the date of vesting is the amount that must be reported as taxable income.

In the continued effort to recruit and retain important personnel and reward excellent performance in the workplace, firms have increasingly resorted to different types of stock awards in recent years. When it comes to executive pay schemes, many people find RSUs and PSUs to be more desirable than real stock because of their unique properties.

But to make an informed decision about the compensation structure of your company you must know the key differences between RSUs and PSUs. This article will guide you on the comparison and provide important factors to consider when choosing between RSUs and PSUs.

RSU, PSU and equity compensation

Most people consider a job offer’s wage and benefits package before making a final decision. In the IT and biotech industries, particularly at startups, “equity compensation” is sometimes included in employment offers, in addition to base salary and other benefits. Supplementing your pay with stock remuneration is an option at public as well as private firms. Startups often include equity pay as a component of their salary packages as a means of enticing new workers to commit to the firm.

Equity compensation and its importance in employee compensation packages

The purpose of equity compensation is to increase the company’s operating capital. The worker is not paid in the form of a salary but rather is given ownership in the business. There are conditions attached to equity pay, such as an initial period in which the employee does not see any return.

Equity compensation is a common tool used by startups to attract and retain high-caliber workers. Many new businesses lack sufficient capital yet can issue shares at whim to compensate investors. The firm benefits greatly from this arrangement since it avoids the expense of wage payments, which might hurt its cash flow in the beginning.

Say, for example, that you decide to bring on a Chief Technical officer (CTO). Their compensation maybe 35% lower than the standard rate, but you may make up the difference by giving them a particular amount of stock.

A brief explanation of RSUs and PSUs

While stock options still have value, other forms of equity distributions are being considered by many companies as part of their pay packages. The first and most important step in introducing any equity compensation plan or program is to be crystal clear on your goals. Once you know what you want to do, you can evaluate your options and choose the one that works best for you.

Recent trends in grant popularity have seen an increase in the use of Restricted stock units (RSUs) as well as Performance stock units (PSUs). Both are similar and yet distinct in some ways. You can consider RSUs and PSUs in addition to stock options if you wish to implement or increase equity pay in your company.

Understanding RSUs

A Restricted Stock Unit (RSU) is a promise by an organization to a worker that the employee will be awarded shares at a future date (the vesting date) if specific requirements are met, such as the employee remains employed by the company for a certain minimum time frame or attaining objectives for performance. The vesting of shares is sometimes contingent on certain events, such as an initial public offering (IPO) or a formal takeover of the firm by another entity. Let’s understand more about it in this section.

Definition of RSUs and how they work

Employees who meet certain performance milestones or who have worked for their firm for a certain period are granted restricted stock units via a vesting scheme and distribution schedule. Until they become fully vested, restricted stock units are only paper promises to workers that they would eventually have an ownership stake in the company. When the RSUs vest, they are valued at their FMV. Once Restricted Stock Units have vested, they are treated as income and a part of the shares must be withheld to cover income tax obligations. The remaining shares are subsequently transferred to the employee, who is free to sell them as they see fit.

Advantages and Disadvantages of RSUs for Employees

The following are some of the benefits of RSUs, as seen from the point of view of an employee.

• RSUs are a very simple equity compensation structure. Awardees will have no trouble understanding the vesting process or determining what their award is worth.
• The recipients will get free shares. It means there will be no need for them to purchase any kind.
• Even if the FMV of the shares decreases between the time of award and the time of vesting, the recipient will always have retained value since they did not pay for the shares.

The disadvantages of an RSU for an employee include the following aspects:

• The tax implications of vesting for employees of private companies can be complex.
• If an employee departs before their RSUs have fully vested, they will often lose out on the unvested portion.
• The stock’s worth may turn out to be less than expected if the FMV upon vesting is lower than expected.

Advantages and Disadvantages of RSUs for Employers

From the perspective of an employer, the following are some of the advantages of RSUs.

• Most employees won’t want to quit the firm while retaining their RSUs, forfeiting the share that hasn’t vested, thus these incentives incentivize workers to stick around for the company’s mid-term goals.
• The administrative burden of tracking and documenting RSUs is lower than that of real stock. Keep in mind that a Restricted Stock Unit (RSU) is nothing more than a promise. You are promising payment with no initial outlay on your part.

For an organization, RSUs have the following drawbacks:

• Employers don’t know the eventual value of RSUs at the time of issuance since the stock is only valued at the time it vests.
• If the value of the stock does not rise much over time or even falls, workers may feel less inspired than they did before.

Understanding PSUs

To better align executives’ and managers’ interests with those of shareholders, performance shares are often offered to them. As they provide management with a clear incentive to concentrate their efforts on generating shareholder value, performance shares have objectives comparable to those of employee stock option plans (ESOPs).

Performance shares, unlike standard stock-option schemes, provide managers with company equity or stock options in exchange for fulfilling goals.

Definition of PSUs and how they work

Performance Share Units (PSUs) are granted to workers based on the company’s long-term success, with the number of PSUs granted often correlated with the company’s success on key criteria over a certain period (commonly three years). As a result, plan members will get a greater number of shares the more the aggregate performance surpasses initial projections. Earnings per share, return on capital, and total shareholder return are three of the most popular indicators of a company’s success in this regard. These are just a few examples of the kind of metrics that could be included in a normal PSU plan.

PSUs will vest and plan participants will receive an equal number of shares as was indicated in the original agreement if the performance targets are met during the performance period. There will be a way to reward participants with more shares than if the firm had only achieved that minimal expectation if performance significantly surpasses what was envisioned as the minimum aim.

Advantages and Disadvantages of PSUs for Employees

Most of the benefits and drawbacks discussed for RSUs are equally applicable to PSUs due to their similarities. Nonetheless, concerning PSUs, the following are also worth mentioning. Among the benefits for workers is the opportunity to amass personal wealth in tandem with the success of the firm via performance shares.

Advantages and Disadvantages of PSUs for Employers

The following are some of the benefits that PSUs provide to companies:

• PSUs have the potential to serve as an efficient incentive and reward tool.
• By giving employees a stake in the firm, this equity incentive may bring about a closer alignment of employee and company interests.

And the disadvantages of PSUs for an employer are:

• Performance shares may be fairly expensive for the business, depending on the conditions.
• There’s also the possibility that workers would act recklessly if they know they’ll be rewarded soon, even if it’s not in the company’s best interest.

Key Differences Between RSUs and PSUs

When an employee receives an award of restricted stock, they usually agree to stay with the firm for a certain length of time. When an employee receives an award of performance shares, they get their shares depending on the success of the company. Here are some more key differences between RSUs and PSUs.

• Vesting schedules – In contrast to RSUs, where vesting may be contingent merely on the passage of time or on the achievement of certain individual performance benchmarks, PSUs are tied only to the success of the firm as a whole as determined by a predetermined set of business measures.
• Performance metrics – Upon completion of the agreed-upon milestone, the employer and employee shall transfer the agreed-upon number of shares to the employee in the form of RSUs. PSUs are often tied to the firm’s overall success, therefore the ultimate share awards may depend on how the company does on certain performance measures.
• Tax implications – The taxation of PSUs bears a resemblance to that of RSUs. The initial award does not incur any liability. However, income tax becomes due upon vesting and is handed over to the individuals. Additionally, capital gains tax applies if the final selling price surpasses the fair market value (FMV) of the shares during the time of vesting.

Comparison of how RSUs and PSUs impact employee motivation and retention

The necessity for employees to stay with the firm is arguably the sole condition tied to the ultimate vesting of shares, making RSUs a more attractive option if employee retention is a key concern.

In contrast, PSUs will always be tied to the company’s overall performance, making them a viable option when the company’s primary goal is to inspire important personnel and promote workplace behavior that contributes to the company’s long-term success.

These goals are not mutually incompatible, since it is true that all businesses want to retain their workers and have them invested in their job and dedicated to the company’s long-term success.

How to Choose Between RSUs and PSUs

The following are a few key considerations to take into account when deciding between Restricted Stock Units (RSUs) and Performance Stock Units (PSUs).

• Industry – Industry competition should influence employee decisions. Companies may employ RSUs or PSUs in highly competitive sectors as a means of attracting and retaining top personnel. For this reason, workers in this situation may wish to compare the prospective worth of RSUs and PSUs to the pay packages given by competitors in the same sector.
• Growth prospects – New product lines, market expansion, and technological or process innovation are major growth drivers. PSUs may be a smart option if the firm has a strong growth track record. RSUs may be advantageous if the company’s development depends on unexpected external variables like regulatory policy or customer preferences.
• Performance Metrics – The value of RSUs is determined purely by the stock price of the firm, and there are often no performance criteria associated with them. But the value of PSUs relies on whether or not certain targets are attained, such as growth in sales, profits per stock, or return on equity.
• Vesting Schedules – RSUs vest gradually, whereas PSUs vest depending on performance. RSUs vest faster than PSUs. The shorter vesting term may benefit individuals who want shares sooner.
• Tax Implications – RSUs and PSUs are subject to a variety of tax repercussions when they are cashed in. PSUs are not subject to taxation until they are distributed, but RSUs are subject to taxation when they become vested based on their value in the open market.
• Employee Preferences – When deciding between RSUs and PSUs, it’s crucial to take employees’ preferences into account. Employees’ compensation choices may vary widely based on their financial situations, risk aversions, and long-term objectives.

How to negotiate equity compensation packages that include RSUs or PSUs

One of the keys to successfully negotiating equity is developing a compelling case for your worth to the firm. You might highlight your unique set of abilities and professional experience to set yourself out from the competition. You might also share your expectations for your time here and why you’re looking forward to working for this specific organization.

Include any pertinent research findings, such as average salary or benefits packages, in your presentation and discussion. Your stake in a corporation might be represented in the form of a percentage or a fixed number of shares. Check to see whether the vesting schedule works with your anticipated time commitment to the organization.

Regardless of whether or when more investors buy the stock at a later date if the corporation records your intended equity as a fixed number of shares, you will possess exactly that many shares. It is important to remember while all aspects of the pay package may be up for negotiation, you may choose to focus on only the equity portion of this discussion.

Get expert help to manage your stock compensation!

Employees of private companies may receive a portion of their compensation in the form of stocks, RSUs, stock options, or additional securities issued by the company. The utilization of equity compensation is a potent strategy that companies can employ to incentivize and retain their workforce. Looking for reliable equity management software? Eqvista is here to help you. As one of the top market leaders, our software makes it a breeze to issue, track, and manage any kind of employee equity plan. To elevate your equity compensation and financial reporting, contact us now!