Determining employee incentives and the overall reward structure relies on decisions regarding employee equity compensation, such as vesting and triggering mechanisms. The single-trigger and double-trigger systems represent two approaches used in this situation. Each system provides distinct advantages and disadvantages, and the choice depends on various criteria, such as business culture, staff retention goals, and market practices.
This article is about Understanding RSUs, Single-trigger RSUs, Double-trigger RSUs, Choosing the right RSU vesting, and Employee stock options comparison.
Restricted Stock Unit (RSU)
Many companies compensate their employees with RSUs (Restricted Stock Units). The units are equivalent in value to the number of shares of common stock. Once vested, the employee has the right to own shares but must pay taxes on the RSU income in the year of settlement.
What is RSU?
Companies offer restricted stock units (RSUs) to compensate employees with company stock. They have restrictions during a vesting period that can last several years. RSUs have some monetary value based on the underlying shares. The entire amount of vested RSUs requires reporting as ordinary income in the year of vesting for tax purposes.
When stock units vest, they qualify as income, and a portion of the shares gets deducted to pay tax liabilities. After the vesting period, the employee is entitled to the remaining shares and can sell them.
How do Restricted Stock Units work?
Once RSU are granted, they typically have a vesting period, during which the employee must remain with the company to become eligible to receive the shares. Once the vesting conditions are met, the employee is granted ownership of the shares.
The value of the RSUs is typically tied to the company’s stock price. When RSUs vest, the employee has the option to sell the shares, holding them as an investment or cashing them in based on the current market value. This allows companies to incentivize employees to stay and perform well, as they receive a stake in the company’s success.
Significance of RSUs
A well-structured RSU program can incentivize employees to commit to a company’s long-term success. Here are some reasons why RSUs are essential and how a strong RSU program may assist in recruiting, attracting, and retaining the best employees.
- Employees gain a sense of ownership in the company through RSUs. The value of the company’s RSUs rises in line with the price of its shares. Aligning their interests with the company’s owners makes employees more invested in its success.
- Employees must continue working for the company during the vesting period for RSUs to receive the total value of the units. This promotes continuity and lowers turnover by incentivizing employees to work for the organization for an extended period.
- RSUs can be linked to performance indicators, guaranteeing that top talent is compensated according to their contributions to the expansion and success of the business. This supports a society that values merit while also inspiring great performers.
- Businesses can stand out in competitive industries by having a well-structured RSU program, demonstrating their dedication to valuing workers as priceless assets, and helping attract and retain employees.
- Companies can delay share issuance until vesting is complete through RSUs, which prevents share dilution.
Two Main Types of RSU Vesting
The two main types of RSU vesting are Single-trigger and Double-trigger.
- Single-trigger RSUs merely have a time-based vesting criterion, compared to the exit event requirement of double-trigger RSUs. As RSUs vest, employees can convert them into shares. Employees can immediately sell their shares to private market investors if the company offers secondary private market transactions.
- Double-trigger RSUs involve a one-year slope and a time-based schedule for employees to earn shares, which tend to be monthly over four years. The second vesting requirement is an exit event requiring an IPO or acquisition for complete ownership.
Understanding Restricted Stock Units
Employees can choose whether to accept or decline restricted stock units. If the worker decides to take the grant, they may have to pay the grant’s purchase price to the employer.
After getting the grant and, if necessary, paying for it, the employee must wait for it to mature. Restricted stock units can have a vesting period based on time (a certain amount of time from the grant date) or performance (tied to the company’s goals).
When restricted stock units have reached their maturity date, employees can get either an unrestricted amount of company stock or cash equivalents, depending on the rules of the company’s plan. Based on the company’s strategy, the company may offer the option to receive stock or cash equivalents later.
The difference between RSU and Employee Equity Compensation
Companies can offer additional compensation through stock options or RSUs at a discounted rate. When you receive stock options, you can buy company stock at a particular price before a specific date. RSUs, however, provide you with the actual shares after the vesting period. The table below has an explanation of some of those distinctions.
|Basis of Distinction||Employee equity compensation (Stock options)||RSU|
|Exercise price||A company's fair market value determines it.||RSUs do not have an exercise price.|
|Vesting||A predetermined vesting schedule governs the distribution of vesting.||Recipients can choose vesting schedules or performance thresholds upon receiving them.|
|Taxation||Taxable upon exercise or sale||Taxable once vested|
|Common uses||Preferred by early-stage or mid-stage start-ups.||Prevalent among public firms and late-stage start-ups.|
Benefits of RSUs for Employees
RSUs provide various benefits to employees, making them a popular component of pay packages. The following are some of the main advantages of RSUs for employees.
- RSUs firmly link an employee’s financial interests to the business’s success. The value of the RSUs rises in line with the company’s stock price, resulting in shared success for both the employee and the industry.
- Employees can diversify their investment portfolios as RSUs mature and convert into shares by selling part of the shares and making new investments. This statement implies that the employee can achieve improved financial planning and risk management.
- Companies grant RSUs to employees to acquire company stock without upfront costs. Employees needing more money to invest in the stock market may find this extremely helpful.
- RSU vesting incurs a tax liability but can also offer tax benefits. Retaining the vested shares could enable employees to qualify for reduced capital gains tax rates.
A single-trigger RSU operates on a service– or time-based vesting schedule. Payments and taxes align with this schedule. A comprehensive evaluation of the settlement conditions is essential to determine the liquidity requirements. A single trigger is likely in place if the vesting or settlement sections don’t necessitate liquidity.
Single-trigger RSUs often have a change in control or a corporate acquisition as the triggering event. A significant event that affects the company’s ownership or control is known as a “change of control”. This could involve a merger, acquisition, or selling of a sizable amount of the business’s assets.
The RSUs “trigger” and “completely vest” when the triggering event occurs, making them eligible for conversion into actual company shares or their cash equivalent. The employer may require employees to pay taxes or withholdings on their vested RSUs.
Example for single trigger RSU:
An employee is granted 1,000 RSUs, and they vest over four years. After four years, the employee owns all 1,000 shares, regardless of any other performance criteria or company events.
|Vesting Condition||In a single trigger RSU, the primary vesting condition is usually time-based.In this case, the RSUs can have 25% vesting each year.|
|Trigger Event||The trigger event for a single trigger RSU is typically based solely on the passage of time. When the predetermined vesting period is complete, the RSUs automatically convert into shares of company stock, and the employee gains ownership.|
Pros and cons of Single-trigger RSUs
Let’s evaluate the benefits and drawbacks of single-trigger RSUs from the perspectives of the employer and the employees.
- Single-trigger RSUs can assist in retaining employees during transition, such as a merger, acquisition, or IPO, when there’s a greater chance of staff departure owing to uncertainty.
- RSUs vest upon a single trigger event, making employees feel more confident about the future value of their stock compensation, especially during difficult times.
- It provides immediate financial gain to employees.
- It aligns employee’s interests with the company’s long-term objectives, which is a positive note for the corporation.
- Investors should refrain from transparent single-trigger acceleration deals as there is a high possibility that many employees will leave after the purchase.
- The new business must also renegotiate excellent benefit packages that encourage critical employees to stick around even after their vested stock has paid out fully.
- Single-trigger RSU configurations may decrease employee productivity when focusing on triggering events.
- Employees have little control over RSU vesting events because it depend on the triggering event.
Double-trigger acceleration calls for two events to trigger acceleration. These events include the sale of a business and the employee’s forced termination within nine to eighteen months after closing, and in some cases, a brief pre-closing window (three months or less) to counter any early termination by the business to avoid a payout.
Example for Double -Trigger RSU:
An employee is granted 1,000 RSUs that vest over four years, but to fully vest, the company’s stock price must reach a specific target (e.g., $100 per share). If the stock price hits this target before the four-year period is complete, the RSUs fully vest. If not, they remain unvested.
|Vesting Condition||The vesting condition includes both time-based and performance-based criteria. Performance criteria can vary and might include hitting certain financial targets, reaching a specific stock price, or achieving certain operational milestones.|
|First Trigger Event||The first trigger event is typically the completion of the time-based vesting schedule, similar to a single trigger RSU. For example, 25% of the RSUs vest yearly over four years.|
|Second Trigger Event||The second trigger event, which is performance-based, needs to occur for the RSUs to vest fully. This second trigger event might involve the company achieving certain financial or operational goals.|
Double-trigger acceleration has gained a lot of attraction with early-stage companies. It aims to align the interests of the employees, investors, and potential acquirers by
- Offering a safety net for critical employees,
- Reducing dilution from automatic acceleration and
- Solving the acquirer’s concerns by preserving the requirement of ongoing service to the company to vest.
Dropbox, Lyft, Pinterest, Uber, and Facebook implement double-trigger vesting, with the acquisition date as the second trigger. It was a significant innovation for the RSUs.
Advantages and potential drawbacks of Double-Trigger RSUs
When comparing double-trigger RSUs to single-trigger RSUs, there are several benefits and potential downsides to consider.
- Double-trigger RSUs provide a greater retention incentive than single-trigger RSUs, requiring the employee to stay with the company during the vesting period and any acquisition or change of control event.
- Employees are encouraged to focus on the company’s long-term success to profit from future acquisitions fully and the increase in company worth over time.
- Double-trigger RSUs connect employee and shareholder interests by linking employee pay to company performance and value.
- The liquidity vesting criterion prevents double-trigger RSU holders from participating in private market liquidity because a secondary liquidity transaction (such as a tender offer) doesn’t count as the second vesting condition.
- Double-trigger RSUs can prevent employees from receiving the total value of their equity pay when corporations add more restrictions to the award.
- Employees will forfeit all the equity in their compensation package if they leave the company before the exit event occurs.
Factors to consider when deciding between Single-Trigger and Double-Trigger RSUs.
Here are some factors to consider when choosing Single Trigger and Double Trigger RSU.
Company’s Growth and Maturity Stage
Double-trigger RSUs may be more appropriate as a company develops and becomes more reliable. A significant shift in control is less likely because the company’s value is more established.
Employers can use double-trigger RSUs to safeguard employees’ interests and match their incentives to long-term business success.
Risk Tolerance and Market Volatility
Single-trigger RSUs offer more certainty than double-trigger RSUs, as the vesting event isn’t dependent on external events such as changes in control. This makes single-trigger RSUs less riskier than double-trigger RSUs.
Double-trigger RSUs may be favorable in volatile markets due to the second trigger connected to a change in control. If the stock price does not move in your favor, vesting may still be advantageous if the acquisition triggers are satisfied and the company’s stock price remains unpredictable.
Employee Engagement and Retention Goals
The employee’s ongoing employment for a predetermined amount of time following the change in control tends to be the second trigger in a Double-trigger RSU. Employees may find double-trigger RSUs more tempting since they offer security in the event of a change in the company’s ownership.
Employees may feel more committed to staying with the organization to profit from the second trigger. As vesting depends on a single condition, single-trigger RSUs may not provide a strong incentive for employee retention.
Potential Change in Control Scenarios
Single-trigger RSUs may fully vest and become instantly due to the employee in the event of a change of control. This means that regardless of any other circumstances, the RSUs convert into actual shares or cash equivalents upon the occurrence of the designated event. Even if they hadn’t met their planned vesting schedule, the employee might still get the total value of the RSUs.
In double-trigger RSUs, change in control constitutes the first trigger, and it’s accompanied by the employees’ continuous stay for the vesting condition to be satisfied.
Legal and Regulatory Considerations
The company should base its decision on single-trigger versus double-trigger RSUs on its current equity compensation plan and other relevant agreements.
With single-trigger and double-trigger RSUs, the taxing period can be different. Employees with single-trigger RSUs must pay income taxes on the RSUs in the tax year they settle.
Pick the right one with Eqvista
Deciding between a single-trigger and a double-trigger vesting structure for your employees necessitates careful evaluation of your company’s goals, culture, and risk tolerance.
Single-trigger vesting could provide workers quicker access to equity, encouraging loyalty and incentives. If workers depart soon after the trigger event, it could result in retention issues. Double-trigger vesting, on the other hand, provides better defense against early departures because it necessitates both a trigger event and a predetermined time commitment. Businesses experiencing rapid growth or facing intense competition benefit from this.