Restricted Stock Units (RSU)

Not all companies these days offer stock options as employee compensation. Many have resorted to other options as a form of employee compensation, such as restricted stock units and restricted stock awards. These new forms of equity compensation offer a lot of benefits both for the employees and the company. But what exactly are restricted stock units and what are their advantages over other forms of stock rewards?

Key Takeaways

• RSUs are stock-based incentives granted to employees for retention.
• RSUs do not require the employee to pay an exercise price, and they will issue the shares of company stock once the vesting conditions are met.
• RSUs cannot be sold or transferred until they vest, which typically occurs over several years based on the vesting schedule. 
• RSUs provide an ownership stake in the company, aligning employee and shareholder interests. If the price rises after vesting, the employee receives profit by selling the shares. 

What is Restricted Stock Units or RSU?

Restricted stock units is a form of employee compensation issued to an employee by a company in the form of company shares. Restricted stock units are issued with a distribution schedule and a vesting plan. Basically, the employee receives shares only after they have accomplished the performance milestones or if they stay for a specific period of time. The rules are all outlined in the plan’s vesting agreement.

Restricted stock units also serve as an alternative to stock options for equity compensation, that gives the employees the right to purchase shares at a fixed price within a fixed time.

Advantages and Disadvantages of Restricted Stock Units

Here are the key advantages of restricted stock units as an employee compensation tool:

• Incentive for Long-Term Retention – RSUs vest over several years based on a vesting schedule, incentivizing employees to remain long-term in order to fully receive their shares. This promotes higher retention of top talent.
• Alignment with Company Performance – Since the value of Restricted Stock Unit is tied to the company’s stock price, employees have a vested interest in the company’s success.
• Tax-Efficient – RSUs are not taxed until they vest and the shares are issued. At that point, their value is taxed as ordinary income. If the stock appreciates further after vesting, any additional gains are taxed at preferential long-term capital gains rates when sold.
• Easier Valuation – The value of RSUs is simply the market value of the underlying shares at vesting, making them easier to value.
• Potential for Significant Gains – If the stock price rises substantially between grant and vesting dates, the vested RSU can provide a lucrative payout.

Here we listed disadvantages of restricted stock units as an employee compensation vehicle:

• Lack of Voting Rights – Employees do not have voting rights until the shares actually vest and are issued. This means they cannot vote on corporate matters during the vesting period.
• No Dividends Paid – Since they do not own the shares until vesting, they are not entitled to receive dividends paid out during the vesting period.
• Potential Forfeiture – If an employee leaves before their RSUs fully vest, any unvested portion is forfeited back to the company they loses that compensation.
• Concentrated Risk – RSUs represent a concentrated position in a single company’s stock, exposing to higher risk compared to a diversified portfolio.
• Vesting Uncertainty – For private companies, the vesting schedule may have a “double trigger” requiring both time-based and a liquidity event like an IPO, creating uncertainty around the actual vesting timeline.

Comparison of Advantages and Disadvantages of RSU

How do Restricted stock units work?

Restricted stock units are employee compensation whose worth is based on the stock value of the company. Once vested, they are distributed as shares or as cash, based on how the deal was initially laid out. But until it vests, the employees have nothing more than just a promise to get in the future. In short, the holders won’t have any voting rights, nor would they get any dividends paid to them. When RSUs grant, they promise to give the recipient shares of the company’s stock in the future for a specified vesting period.

But the moment the shares are vested, they get distributed employee has to pay tax on the value of the shares at the time of vesting. The vested shares or cash equivalent is subject to ordinary income tax rates. When employees receive the actual shares of company stock for free they are required to pay to purchase shares.

Let us take an example

Let’s assume that Moni gets a job offer in 2013 and is offered 2,000 RSUs over five years, which is considered to be a part of her compensation package to stay in the company. Let us assume that the stock of the company is worth $20 per share at that time. This makes the restricted stock units offered worth $40,000.

The RSUs would be fully owned by Moni after the 5 year period as per the company’s vesting schedule. As per the plan, after one year of employment in 2014, Moni would get 20% of the total plan for 400 shares. The next year she gets 400 more and it continues like this until after the vesting period ends in 2018, she becomes the owner of all the 2,000 RSUs. In short, based on how the company performs, Moni would get at least $40,000 if the price stayed the same or increased.

This is how the vesting plan would look on Eqvista:

When should you sell RSU shares?

If you have been granted restricted stock units by your company subject to a timed-vesting schedule, then will have to decide periodically what you want to do with the shares you get. In fact, what you do with the shares would help you in the financial planning of your future. This is especially true if the overall value is an appreciable portion of your net worth.

One option is to sell as soon as they vest and add the gains to an investment plan for your future. You can also hold your shares for longer so that you can benefit by paying less taxes as long-term capital gains tax when you sell after holding it for years. In this case, you will have to wait for a liquidity event for your private company before you can sell your shares. Or if you want to sell it before this happens, find a willing buyer to purchase them.

If your company goes public, you can sell your shares on the open market. Just ensure that you meet the criteria for selling and you are complying with the trading policy.

When you are thinking of selling your RSUs, it is always a good idea to consider things like:

• Your cash-flow needs.
• Your company’s trading policy.
• How do you think the stock will perform in the future?
• How much would you be taxed?
• How diverse do you want your portfolio to be?

With all these considered, you will be able to decide the best time for you to sell the stocks. Everyone has their own situation in life and that is why you need to see what is best for you.

RSU Vesting

Restricted Stock Unit vesting is a form of employee compensation that gains ownership of company shares granted to them as part of their compensation package. This has a vesting schedule determining when the employee receives the shares.

Common vesting schedules include:

• Time-based vesting – A portion of RSUs vest at regular intervals (e.g., 25% per year over 4 years).
• Cliff vesting –  No RSUs vest until a specified period (e.g., 1 year), after which a large portion vests at once.

RSUs typically vest based on continued employment over a set period. Some RSUs may also have performance-based vesting conditions tied to company or individual goals. If employment is terminated before full vesting, unvested ones are generally forfeited.

Agreements may allow for accelerated or full vesting upon certain events like:

• Change in control (acquisition, merger, etc.)
• Retirement or termination without cause.

RSU vesting schedules determine when employees receive ownership rights over the granted company shares, incentivizing long-term employment and aligning company interests.

How are Restricted stock units taxed?

The person who receives restricted stock units is taxed when the shares come into their hands. The taxable income is the market value of the shares at the time of vesting. These are subject to the federal and employment taxes including Social Security and Medicare taxes. Along with this, those who holds the vested RSUs will also have to pay any local and state taxes too, as the income gained is subject to mandatory supplemental wage withholding.

A company might offer different ways to pay taxes at vesting, or can use just one single mandatory method. One of the most common ways that companies use is taking the amount of the newly delivered by surrendering stock back to the company.

RSU vs ESOP

The choice of Restricted Stock Units and ESOPs depends on the company’s growth stage and employees’ risk tolerance. ESOPs offer them the opportunity to buy shares of company stock at a fixed price that can lead to higher rewards simultaneously, with great risk of financial commitment and tax. On the other hand, restricted units are considered safer and more straightforward in the form of employee compensation, in which employees receive directly upon vesting without purchasing them.

Here are the key differences:

Manage RSU with Eqvista

Now that you know all about what restricted stock units are and how they work, you can move ahead and offer them to the employees in your company. But as you do this, make sure that you keep a track of all the shares.

Eqvista is an advanced cap table management platform where founders can manage shares, issue ESOPs, RSU, add vesting schedules, and do a lot more. Eqvista helps companies stay compliant with regulations like 409A valuations for RSUs. Eqvista’s platform simplifies the process of creating and managing vesting schedules, including for RSU grants to employees. Check out the software and try using it today!