Restricted Stock Units Explained

When tech companies grant employees equity compensation, it is usually in the form of stock options or restricted stock units (RSUs). Although there are pioneers like Spotify, employees generally won’t get the opportunity to choose their preferred equity type. Rather, the equity-type and amount you receive will depend on your role, the size, and stage of your company. Restricted Stock Units (RSUs) are relatively new when compared to their stock option counterpart. They have become a popular means of awarding company equity to employees not just by tech startups but also by much larger and more established public companies. Regardless if you’re an employee at a startup or a blue-chip tech company, you’ll benefit from restricted stock units explained. 

Restricted Stock Units Explained

RSUs holds no value when they are granted to you. They are only a company’s promise to give you shares of the company’s stock or the cash value of the company’s stock on a future date if certain restrictions are met. Unlike stock options, RSUs always have some value to you at the vesting date. Unless, one way or another, the stock price drops to $0. Nonetheless, the key benefit is that RSUs are always worth something and should always result in some form of income for you, even if the stock price drops below the grant date’s price.

For example, your company grants you 125 RSUs. When the shares are delivered to you, the company’s stock price was $150 per share. The value of the grant is then worth $18,750 (125 x $150). If the stock price is $120 when they are delivered to you, the grant value would be worth $15,000. Accordingly, it does not matter what the stock price was on the grant date or any other date except the date of delivery. 

How are RSUs restricted?

In order to receive your RSUs, certain restrictions must be met. For most public tech companies, these restrictions are usually time-based and tied to employment. In other words, you must stay at the company for a certain amount of time to receive your promised RSUs. This time-based restriction is known as a vesting schedule. Graded vesting can occur in increments over the course of the vesting schedule. For instance, new shares can be delivered annually or each month. Alternatively, all the shares can be delivered at once in what is known as cliff vesting

How are RSUs taxed?

With RSUs, you are generally subject to ordinary income taxes on their market value when the shares vest and become yours outright. However, there are specialized RSU plans that may allow you to defer the delivery of your shares, giving you more control of ordinary income taxation. In any case, your company may offer you a few ways to elect to pay taxes due at vesting. Some options include deductions from your salary or payment by check. However, the most common is selling a portion of your vested shares and using the proceeds to cover tax liabilities. At that point, you can choose to either hold the remaining shares in your portfolio or sell them right away. 

Why would I sell my RSUs right away?

 When considering whether to sell your RSUs, it’s best to think about:

  • How much you’ll be taxed
  • Your cash flow needs
  • How you think the stock will perform in the future
  • How diverse you want your portfolio to be

When you sell your shares, you may be subject to capital gains tax on any appreciation over the stock price on the vesting date. In other words, capital gains is the difference between the stock price when the shares vests and when they are sold. The length of time you hold the shares usually determines whether you will pay short-term or the more favorable long-term capital gains tax. Keep in mind, if you sell the shares immediately after vesting, you likely won’t experience any gains and may not be hit with the additional capital gains tax. 

Although it is important, taxes shouldn’t be the determining factor when considering selling your shares. There are also concentration risks inherent when dealing with RSUs and other types of equity compensation. Any concentrated stock holding is risky. Still, when it’s your own company’s stock, you are exposed to an escalated level of risk if the company falls on hard times, especially during an economic downturn. 

Like everything else financially related, decisions around equity compensation shouldn’t be made in isolation. They should align with your overall financial plan. 

Dreams Money Can Buy

For most of us, dreams money can buy is symbolic of something much more significant than money itself. When we talk about money, most of the conversation is rooted in how to make or keep more of it. We create budgets to keep track of and reduce our expenses so we can save more. We often talk about how to negotiate for more equity or higher pay to earn more. Once we’ve amassed that cash, we look at how to wisely invest so we can enjoy it today while growing a reserve for the future.

What we don’t often talk about is how to spend that money to create the life we want. But knowing how to spend our money — or more precisely, use money as a tool — is a critical part of financial planning that’s often discounted.

The truth about money

Money is a tool. On its own, it is neither good nor bad; it is a means to an end. If anything, money is merely a means of exchanging value for value. In many circumstances, the truth is the problem isn’t money alone. It is in the lens through which we view money, how we approach money, and how we handle money.

While we should explore our feelings towards money and strive to manage it better, we should not allow our desire for more to consume us. Don’t get me wrong. There isn’t anything wrong with wanting more money, per se. Many affluent people have worked earnestly to attain the success necessary to accumulate wealth. It is the prioritization of accumulating money at all costs, that’s the problem. It is in this relentless pursuit that many of us realize that money is not, and never will be, the answer to what makes us happy. 

Indeed, while money can help us find happiness, we shouldn’t just expect it because it only represents half of the equation. The key is using money to afford experiences and memories, not just material things. In the grand scheme of things, money should enhance our lives, not control it. 

Think of money as a tool, not as a goal. 

Money is important because it enables us to have more control over our lives. In essence, it is a tool that affords us the freedom to carve out our own path and have fewer constraints on our choices. When we shift our perspective to view money as a tool that permits us to grow our wealth and do the things we want for as long as we want, we’ve come one step closer to enjoying a mindset of fulfillment. Let me give you an example.

Let’s say you inherited a million dollars and decided you wanted to purchase your dream car. Let’s go with a Porsche and estimate the car payments to be about $800 per month.

Most people would likely finance and start making monthly payments or buy the car outright. After all, you have a million-dollar stash.

But, those who view money as a tool, might do something as simple as this: Place the million dollars in an interest-bearing account that produces a 1% return and then use the $833 per month of accumulated interest to pay for the car.

Rather than spending money on the car and taking away from the newfound million, you’d get to have your cake and eat it too.

While this example may be somewhat one-dimensional, it inevitably demonstrates the idea of using money as a tool to kindle fulfillment.

Live with money, not for money. 

Money only has value when you use it to live your life. Not only this, but how you manage your money should be determined entirely by your personal goals and values. The way I see it, money is a tool that empowers us to protect ourselves, build a legacy for ourselves and our family, and give back to our community. For me, that’s the reasoning behind its significance. If you can master this money mindset, you’ll be further along than most.

Dealing With Volatility In Your Company Stock

Stock options, RSUs, and ESPPs are all valuable forms of equity compensation. They are often used to align the incentives of both an employer and its employees. If you own company stock, you may have experienced market volatility, and have seen firsthand how swiftly change in the stock price can change the value of your equity. Amid a strong economy and thriving stock market, the stock price can skyrocket. Possibly to such an effect that it can create a concentrated position in your company’s stock — the opposite of diversification. And in all honesty, this concentration isn’t necessarily a bad thing. It genuinely depends on your unique circumstances and goals.

As quickly as your company’s stock price rises, they can fall, and in unsettling ways. As you can imagine, that will affect the value of your equity grants and holdings of company stock. When the market becomes uncertain, and things aren’t going well for your company’s stock, it’s important to remember that equity compensation is a long-term deal. Thankfully, there are a few behavioral tricks at your disposal when dealing with volatility in your company’s stock.

Understand What You Have And How It Works

It’s critical to be familiar with the type of equity compensation you have, whether non-qualified stock options, incentive stock options, restricted stock, restricted stock units (RSUs), or an employee stock purchase plan (ESPP). The nature of the equity compensation type will affect its perceived value and ultimately shape your expectations. 

Let’s take a look at stock option grants. Most of them have a 7-10 year life or exercise window. Even if your company’s stock price were to fall or fluctuate soon after receiving the grant, stock options have significant leverage if the price rises later. Although there aren’t any guarantees in the world of investing, the potential upside can be very rewarding. On the other hand, RSUs always have value when they vest and belong to you outright. If you’re at a company like Spotify, where you can select a mix of equity types, RSUs can balance out some of that volatility that is inherent with stock options. 

Play The Long Game

When thinking about equity compensation, stop expecting quick riches. Even the rocket ships and unicorns require time, patience, and dedication. If it helps, try to think of equity comp as a tortoise rather than a hare. I understand this perspective is easier said than done, but that’s even more reason to develop a financial plan that considers your values and goals when dealing with volatility with your company’s stock. Ultimately, this is the essence of holistic financial planning. At best, you will gain clarity and confidence in your financial life and decision-making in good AND bad markets. At worse, you’ll have a back-up plan tucked if and when plan A doesn’t come into fruition. 

Volatility Can Present Opportunities

Volatility and your company’s stock go hand in hand. Not to mention, it can also present a valuable opportunity to assess your tolerance for risk in real-time. When in volatile markets, evaluate your comfort level with financial risk, and gauge how you feel about your asset allocations, including company holdings and retirement accounts. If you find it too challenging to deal with volatility in your company’s stock, you may want to consider diversifying some or all of your portfolio. You’ll likely be less worried about volatility when your financial future is less dependent on a single company or stock. 

Manage Your Expectations

Your cash flow is best tied to your base salary, not to investments in your company’s stock. Moreover, relying on gains from equity grants can lead to altering feelings of ecstasy and anxiety — a rather unhealthy combination. If you must sell company stock for cash to pay for living expenses or other urgent financial demands, there are a few key areas of financial planning first to understand. 

It’s a personal preference in my household to separate investment income from our lifestyle needs as it provides an additional layer of protection against stock price volatility. We don’t depend on stock options or RSUs to cover regular expenses. Instead, we’ve earmarked it for flexible goals like going on vacations or buying our dream cars. In that way, we’re not let down if the stock price tanks and our lifestyle wouldn’t be largely affected.