In recent years (really, since Facebook), it’s become increasingly popular for private companies to issue restricted stock units (“RSUs”) in lieu of stock options or other equity compensation. Here, we tick through the most important things you should know to understand RSUs.
1. What are RSUs?
A RSU is an equity award valued in terms of common stock to be delivered at a future date. Upon vesting (see below), the company will deliver to you shares of its common stock. Unlike options, it does not matter what the value of the RSUs are on the grant date. So, for example, if the company issues you 10,000 RSUs, their value, for all intents and purposes, is determined upon vesting (price per share at time of vesting X 10000).
2. How do RSUs vest?
RSUs can vest in a variety of ways, at the company’s discretion. However, it’s often not the standard vesting schedule associated with options (four years with a one year “cliff”). It’s common for RSUs at private companies to vest upon the satisfaction of both (i) a service condition and (ii) a performance condition. The service condition requires you to work at the company for a certain amount of time, often four years (although the “cliff” period can still be one year) to fully vest your award. The performance condition is tied to a liquidity event at the company—its IPO or its acquisition by another company.
3. Let’s talk about tax, baby
There is no taxable income on RSUs at the time they are granted, because you have not yet received any stock. Upon vesting, you will receive stock at the fair market value (FMV) at the time of vesting. This is considered compensation (not merely income, so it’s subject to withholding) in the year of vesting and it’s taxed at the ordinary income rate. For example, let’s say you were awarded 100 RSUs. Upon vesting, you would receive 100 shares from the company at their FMV; let’s say this is $10 per share. One wrinkle to note here is that companies often “sell to cover”—that is, they will sell enough shares to cover the withholding and then issue you the balance. You may receive 80 shares after this is done with a basis of $800. Your W-2 for the year of vesting would show additional compensation of $1000, with $200 in additional withholdings.
Your holding period for the 80 shares would begin on the date of issue, which is typically (but not always) the date of vesting. For example, Twitter’s RSUs are issued within 30 days of vesting. When you sell the shares, it’s taxed as any other stock sale (subject to capital gain and loss).
4. How are RSUs different from other options?
There are a few key differences. First, unlike an option, there is no exercise price. So a RSU will always have value. (It can never be “under water”.) Second, the tax treatment is very different. RSUs are taxed as soon as they vest and are issued. Options are not taxable until they are exercised (they can vest before they are exercised), and even in many instances, incentive stock options have no tax impact at the time of exercise.
5. Why would a private company give me RSUs and not options?
RSUs tend to be fashionable among the unicorn set. You really only see them with later stage, high valuation private companies (Twitter, Facebook, Dropbox). On its face, it doesn’t make sense for a company to issue its employees RSUs because they don’t align incentives. Unlike ones with options, an employee awarded RSUs will receive value regardless of whether the company appreciates in value. So why have the unicorns gone the RSU route? When you have just raised a funding round at a $1 billion valuation, the exercise price on future options issued will be pretty darn high. It may take some time for the company to actually achieve its valuation, diminishing the value of the options in the eyes of the holder. Simply put, astronomical valuations make it harder to recruit talent because of the impact on the exercise price of options.
