Restricted Stock Units (RSU)
Let us dive into the topic and understand everything to know about restricted stock units.
Not all companies these days offer stock options as employee compensation. Many have resorted to other options to reward their staff, 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?
Restricted stock unit or RSU
Restricted stock units, or RSUs for short, is a form of compensation issued to an employee by a company in the form of company shares. Restricted stock units are issued to an employee with a distribution schedule and a vesting plan. Basically, the employee will get the shares only after they have accomplished the performance milestones or if they stay with the company for a specific period of time. The rules are all outlined in the plan’s vesting agreement.
Advantages of Restricted stock units
Restricted stock units have a lot of advantages. To begin with, RSUs offer an employee with the incentive to stick with the company for a long time and help it grow so that the share price can grow as well. And in case the employee decides to hold their shares until they are completely vested, the share prices increase in most cases. When this happens, the employee gets the capital gains minus the value of the shares withheld in taxes, where the amount due is for capital gains tax.
Along with this, the administration costs for setting up a restricted stock units plan is very low. Since there are no actual shares given out in the plan, the employer would not have to worry a lot about where the shares are going. RSUs also permit the company to defer the issuance of shares until the vesting completes. This helps in delaying the dilution of the shares for the current shareholders in the company.
How do Restricted stock units work?
Restricted stock units are employee compensation whose worth is based on the stock value of the company. Once the RSUs are vested, they are distributed as shares or as cash, based on how the deal was initially laid out. But until the restricted stock units vest, the employees have nothing more than just a promise to get shares in the future. In short, the holders won’t have any voting rights, nor would they get any dividends paid to them. In some instances companies offer dividend equivalents on RSUs to the shareholders, used to cover the taxes on the vested shares.
But the moment the shares are vested, they get distributed to the employees. When this happens, the 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.
Let us take an example
Let’s assume that Moni gets a job offer from a company in 2013 and is offered 2,000 RSUs over five year, 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. And that is how restricted stock units work!
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 of the shares is an appreciable portion of your net worth.
One option is to sell your shares 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 company’s trading policy. In fact, it is always a better idea to check the rules of the firm before you sell company shares, as in some companies, you can only trade the stock during a certain period of the year.
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.
How are Restricted stock units taxed?
The person who receives restricted stock units is taxed when the shares come into their hands. This is basically every time a part of the shares is vested. The taxable income is the market value of the shares at the time of vesting. The shares that vest are subject to the federal and employment taxes including Social Security and Medicare taxes. Along with this, employees holding 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 through which employees can pay taxes at vesting, or can use just one single mandatory method. It all depends on the company. One of the most common ways that companies use is taking the amount of the newly delivered shares by surrendering stock back to the company.
RSU vs ESOP
Restricted stock units are very different from ESOPs. RSUs are stocks given to the employees without any compensation taken in return. However, these shares come with some restrictions on the timeframe to sell them. ESOPs are also stock compensation plans offered to employees. However, in this case, the stocks are not given to the employees instantly. The employee is given the option to purchase the shares of the company at a predefined rate and at a future date.
Here are the key differences:
|Basis of Comparison||Restricted Stock Units||Stock Options
|Offered date||RSUs can be issued at any time after the issuance.||Stock options can be issued any time after the issuance.|
|Shareholders’ right||The restricted rights of the shareholders are offered.||The full rights of the shareholders are offered.|
|Settlement after vesting||For RSUs, terms are followed and the shares offered are settled. The settlement can be deferred for receiving tax benefits to a certain extent.||Once the vesting period ends, stock options become available. After that, it is the employee’s choice to select how they want to exercise the option.|
|Payment during settlement||Cash/Stock||Stock
|Tax treatment||Taxes are based on vesting in RSUs. If at the time of settlement when the employee gets the stocks, and they keep the stock for more than 12 months, then capital gains treatment can be possible.||Taxes are paid at the time of sale at the long-term capital gain rate (for qualifying disposition) for the stock options. Otherwise, for non-qualifying disposition, taxes are paid at the time of sale at the income tax rate.|
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 company 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. Check out the software and try using it today!