Restricted Stock Units

By Jon Scott

RSUs

Abstract: This article explains Restricted Stock Units (RSUs) which are shares granted to an employee as part of their compensation package. Those who are considering job offers at startups or companies that grant stock as part of employee compensation should review this article.

Thinking of joining a startup? This article explains the most important variable in your compensation package. Restricted stock units (RSU) are shares awarded by the employer to an employee–meaning the employer is granting the employee ownership in the company. There are typically two ways you can receive stock as an employee, one way is RSUs, the other is Employee Stock Options (ESOs) where an employer will grant you access to purchase those shares at a certain date.

Vesting Schedule

RSU are typically governed by a vesting schedule, which is where an employee is given ownership of the stock units once the stock becomes fully vested. The employee does not have ownership of the shares while they are vesting and the employee will forfeit any shares that are not fully vested at the time of separation from the company. However, once the shares become fully vested the employee has the right to hold or sell the shares.

Typically, vesting is tied to a timeframe, but an employer may also tie the vesting to certain milestones or achievements. An example would be a 4 year vesting schedule with a 1 year cliff. This means it will take 12 months for 25% of your stock to vest, and another additional year for another 25% to vest. At 4 years all of your stock is fully vested. Another vesting schedule is hybrid vesting, where RSU vest based on both time and milestones. Lastly, there is an option for immediate vesting, where shares become available as soon as they are granted.

What Happens to RSUs when the company goes public?

Once the company goes public, any vested RSUs turn into actual shares. However, the next actions the shareholder can execute depends on a couple factors. Upon going public, many shareholders are subject to a lock-up period stipulating that shareholders can only sell a certain number or percentage of shares (or none at all) for a specific period of time.

How are RSUs Taxed

RSUs are taxed at the point of vesting. Specifically, the shares are taxed at the full fair market value (FMV), meaning 100 shares vested at a FMV of $10 will be valued at $1000 and subject to income taxes. Once the stocks are fully vested you are able to sell shares. However selling the shares before one year of ownership at a higher price than the FMV at the time the shares vested will result in short-term capital gains tax at your federal income tax rate. If you hold your shares longer, the shares would be considered long-term and typically taxed at a lower rate.

When is the best time to Sell RSUs?

The best time to sell RSUs will depend on the company and market conditions. However, the safe bet is to sell your RSUs immediately after vesting. This is because there are no capital gains tax due because the shares have neither increased or decreased in value. Another benefit to selling the shares right away is the ability to reinvest the shares in another investment.

Whether to keep your shares or not will also depend on your personal financial situation. As previously mentioned, keeping your shares will mean capital tax gains at short-term or long-term rates depending on the value and length you hold the shares. An employee can potentially have a large amount of their networth tied up in company stock, and the only way to unlock the cash value of those shares is to sell those shares and receive the cash. Selling shares and reinvesting the cash is also a way to diversify your portfolio in the case that the value of your RSUs falls dramatically. Remember, start-up companies are often very volatile in terms of quarter to quarter financial performance (as far as revenue, free cash flow, etc). Therefore, the value of a startup's RSUs can vary dramatically over time. Having a large amount of your net worth tied up in one company is rarely a good idea, meaning diversifying your portfolio once your RSUs are vested may be a beneficial idea.

What is the importance of RSUs when negotiating a job offer?

Negotiating a job offer involves many different factors, and RSUs are often a very important element–especially at start-ups. For example, an employer may offer a cash compensation of $75,000 and $20,000 of RSU vesting over four years with a one year cliff. In this example, your total yearly compensation is $80,000 ($75,000 cash and $5,000 in RSUs). However, keep in mind that the value of those RSUs will likely fluctuate over time, therefore it may be beneficial to ask for a larger cash compensation if you are worried the value of those shares will decrease. Alternatively, you will want to negotiate a larger number of shares if you believe the company’s value will grow substantially over time. However, realize that no one has a clear crystal ball about future economic conditions.

Again, you want to make sure that the company’s stock is not a significantly large portion of both your compensation and portfolio value. Any company–whether a startup or not–is not shielded against a sudden large drop in share value, so having a compensation package that provides sufficient cash compensation is vital.: This article explains Restricted Stock Units (RSUs) which are shares granted to an employee as part of their compensation package. Those who are considering job offers at startups or companies that grant stock as part of employee compensation should review this article.

Thinking of joining a startup? This article explains the most important variable in your compensation package. Restricted stock units (RSU) are shares awarded by the employer to an employee–meaning the employer is granting the employee ownership in the company. There are typically two ways you can receive stock as an employee, one way is RSUs, the other is Employee Stock Options (ESOs) where an employer will grant you access to purchase those shares at a certain date.

Vesting Schedule

RSU are typically governed by a vesting schedule, which is where an employee is given ownership of the stock units once the stock becomes fully vested. The employee does not have ownership of the shares while they are vesting and the employee will forfeit any shares that are not fully vested at the time of separation from the company. However, once the shares become fully vested the employee has the right to hold or sell the shares.

Typically, vesting is tied to a timeframe, but an employer may also tie the vesting to certain milestones or achievements. An example would be a 4 year vesting schedule with a 1 year cliff. This means it will take 12 months for 25% of your stock to vest, and another additional year for another 25% to vest. At 4 years all of your stock is fully vested. Another vesting schedule is hybrid vesting, where RSU vest based on both time and milestones. Lastly, there is an option for immediate vesting, where shares become available as soon as they are granted.

What Happens to RSUs when the company goes public?

Once the company goes public, any vested RSUs turn into actual shares. However, the next actions the shareholder can execute depends on a couple factors. Upon going public, many shareholders are subject to a lock-up period stipulating that shareholders can only sell a certain number or percentage of shares (or none at all) for a specific period of time.

How are RSUs Taxed

RSUs are taxed at the point of vesting. Specifically, the shares are taxed at the full fair market value (FMV), meaning 100 shares vested at a FMV of $10 will be valued at $1000 and subject to income taxes. Once the stocks are fully vested you are able to sell shares. However selling the shares before one year of ownership at a higher price than the FMV at the time the shares vested will result in short-term capital gains tax at your federal income tax rate. If you hold your shares longer, the shares would be considered long-term and typically taxed at a lower rate.

When is the best time to Sell RSUs?

The best time to sell RSUs will depend on the company and market conditions. However, the safe bet is to sell your RSUs immediately after vesting. This is because there are no capital gains tax due because the shares have neither increased or decreased in value. Another benefit to selling the shares right away is the ability to reinvest the shares in another investment.

Whether to keep your shares or not will also depend on your personal financial situation. As previously mentioned, keeping your shares will mean capital tax gains at short-term or long-term rates depending on the value and length you hold the shares. An employee can potentially have a large amount of their networth tied up in company stock, and the only way to unlock the cash value of those shares is to sell those shares and receive the cash. Selling shares and reinvesting the cash is also a way to diversify your portfolio in the case that the value of your RSUs falls dramatically. Remember, start-up companies are often very volatile in terms of quarter to quarter financial performance (as far as revenue, free cash flow, etc). Therefore, the value of a startup's RSUs can vary dramatically over time. Having a large amount of your net worth tied up in one company is rarely a good idea, meaning diversifying your portfolio once your RSUs are vested may be a beneficial idea.

What is the importance of RSUs when negotiating a job offer?

Negotiating a job offer involves many different factors, and RSUs are often a very important element–especially at start-ups. For example, an employer may offer a cash compensation of $75,000 and $20,000 of RSU vesting over four years with a one year cliff. In this example, your total yearly compensation is $80,000 ($75,000 cash and $5,000 in RSUs). However, keep in mind that the value of those RSUs will likely fluctuate over time, therefore it may be beneficial to ask for a larger cash compensation if you are worried the value of those shares will decrease. Alternatively, you will want to negotiate a larger number of shares if you believe the company’s value will grow substantially over time. However, realize that no one has a clear crystal ball about future economic conditions.

Again, you want to make sure that the company’s stock is not a significantly large portion of both your compensation and portfolio value. Any company–whether a startup or not–is not shielded against a sudden large drop in share value, so having a compensation package that provides sufficient cash compensation is vital.