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. 

Recommended Posts