Do you work for an employer that granted you restricted stock units (RSUs)? This form of non-cash compensation has become increasingly popular among start-ups and Fortune 500 companies alike that are using RSUs to lure new hires and retain senior executives to create a culture of ownership. As employers continue to grant fewer stock options than in years past, the granting of RSUs is becoming more common.
RSUs can be beneficial for both employees and employers as they help to align the interests of both. Let’s examine some of the different aspects of this increasingly popular form of compensation.
What are Restricted Stock Units?
Employees granted RSUs have received a deferred and restricted grant which become shares of stock upon vesting. An employer offers Restricted Stock Units to recruit, incentivize, compensate, and retain key employees. The employer commits to giving an employee stock in the company on a certain date in the future (known as the “vesting date”) once certain requirements are achieved. Vesting is usually tied to continued employment until the vesting date, but predetermined performance requirements can also be used to determine RSU awards.
RSUs have no actual value to the employee until they are vested. On the vesting date the value of the stock represented by the RSUs determines the amount of compensation earned by the employee. If the company does well, the value of its stock should increase with time, increasing the value of the shares the RSUs represent. Income from RSU’s is treated as ordinary income at the time the RSU’s vest. Shares are commonly sold to cover the necessary tax withholding. If you continue to hold shares after the vesting date the rules covering capital gains will apply to any future appreciation.
For example, let’s say your company grants you 1,000 RSUs when your company’s stock price is $10. The stock price has since risen to $20 by the date your RSUs vest. In this scenario, the 1,000 RSUs would be worth $20,000 of stock (before taxes) on the vesting date.
What are the Advantages and Disadvantages of RSUs?
There are a number of potential benefits and also some drawbacks of RSUs. Below, we break down some of these factors for both you and your employer:
For You, the Employee:
Earn Company Ownership: You receive an economic interest in the company in the form of future stock shares.
No Upfront Investment: Unlike traditional stock options, RSUs are a grant. You do not have to make an upfront investment to exercise your right to buy the stock. With RSUs, once the shares vest, you own the stock at the then-current market value.
Clear Value: Unlike stock options – which can be worthless if the share price falls below the option price – RSUs will still hold some intrinsic value if the stock price falls instead of rises between the issuance and vesting date (barring insolvency of the company).
No Value Until Vesting: If your employment ends before the vesting date your RSUs are forfeited.
No Initial Voting Rights: RSUs provide no company voting rights to you, until the RSUs vest and convert to shares of stock.
No Initial Dividends: Again, you have no legal right to stock dividend payments before the units vest and convert into stock (though some companies have been known to voluntarily compensate RSU recipients during the vesting period in lieu of dividends).
Defer Income Taxation: RSUs are not taxable upon issuance, but instead upon vesting. Therefore, no income taxes need to be paid up-front on this form of deferred compensation. Instead, you pay taxes on the total grant in the year of vesting, where the amount of taxable income is determined by the fair market value of the RSU award on the vesting date.
No 83(b) Election: Unlike straight restricted stock, holders of RSUs do not have the option to pay income taxes on the RSU grant at issuance. Income taxes on restricted stock must be paid upon vesting.
For Your Employer:
Recruit and Retain Key Employees: RSUs are a useful tool for your company to hire and keep talented and in-demand employees, by allowing them to financially benefit from the company’s future growth.
Lower Costs: Your company can provide compensation incentives without expending any cash up-front. This is particularly beneficial to earlier-stage, cash-constrained companies. In addition, administration costs are low as there are no actual shares to track and record until the vesting schedule is complete.
Delay Stock Dilution. Stock dilution is defined as the reduction of equity ownership by all shareholders as a result of the issuance of new shares. Unlike other types of equity compensation, the issuance of RSUs do not immediately add to the company’s share count, which is favorable to your company. RSUs allow your employer to defer issuing shares until a later date, which therefore helps to delay stock dilution to existing shareholders.
Talk to Your Advisor
When it comes to RSUs, there can be many different complexities, some of which may be unique to your employment or financial situation. Your adviser can help you both better understand your RSU award and navigate its potential implications for your overall financial plan.
To learn more about the ways Modera can help you achieve your financial goals, please contact us.
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