The Ultimate Guide to RSUs: What They are and How They Work

By Shubhankar

SP Investing about RSU Restricted stock units

 

Restricted stock units (RSUs) are a popular equity incentive program. A company will grant an employee an RSU, which is essentially a promise to deliver shares of the company’s stock at a later date. The timing and quantity of the shares are usually contingent on performance and time spent with the company. There are many variations on how an RSU program can be structured. To understand the nuances of RSUs, you need a comprehensive guide to help you determine if this type of equity award is right for you and your career trajectory. This guide covers all the information you need to know about RSUs so you can make the best decision for your future.

 

What Are Restricted Stock Units?

A restricted stock unit (RSU) is an employer's promise to deliver stock shares at a later date. The employer will typically specify a vesting schedule, meaning you will have to wait for the company to follow a schedule for distributing the shares. RSU programs have become more common in recent years as more companies have looked to tie equity compensation to specific metrics, rather than grant a set number of shares. RSUs are typically granted as part of a larger equity plan and are often considered more flexible because of their variety of design options.

 

RSUs are usually given to employees in lieu of cash compensation. When an RSU is granted, an employee receives a specified number of company shares at a specified future date, often referred to as the “vesting date.” Usually, only a certain percentage of the given shares can be received each year until the vesting date.

 

For example, if an RSU is worth $100,000 and is granted on October 31, 2016, the employee will receive 10,000 shares on October 31, 2017. If the shares were worth $100 each at the time of the grant, the employee would receive 10,000/100 = 100,000 in total.

 

How do RSUs work?

The timing of an RSU grant will depend on the terms of your company’s equity program, but in general, the process works as follows: - Company decides to grant equity to employees, either as part of an equity award or as part of a promotion (e.g., you get a promotion to director, and you’re granted RSUs equal to the amount that a director would get). - The company establishes an equity program and decides whether RSUs or stock options are the best vehicle, as well as what the terms of the program will be. - The company announces the equity program and grants equity awards to employees. - Employees who are granted RSUs have to wait for a specified period before they can exercise their options and receive the shares. This is called the vesting period. - After the vesting period has passed, the employees can exercise their options and receive the shares.

 

Why Do Companies Use Restricted Stock Units?

Companies use equity incentives such as restricted stock units (RSUs) to attract top talent and retain employees. Equity represents a stake in the future of a company, and although it’s not guaranteed that the investment will be profitable, it does offer more security than a salary does. This type of compensation is especially useful for startups, where the promise of equity alone can help attract talented employees. The terms of equity-based compensation are legally binding and can be more easily tracked and audited than a bonus or salary.

 

RSU Mechanics: Overview

A vesting schedule is commonly applied to RSUs, so let’s start with that. - The vesting schedule is a specified period of time that you must wait before you can exercise your options and receive the shares. - It’s common to start with a one-year vesting period, with 25% of the shares vested at the end of each consecutive quarter for the remainder of the year. - At the end of the year, you will have 100% of the shares vested.

 

Timing of RSUs

The timing of your RSUs will determine the amount of shares, if any, that you will receive. 

The timing of when you join the company—whether you are a new hire or an existing employee—will determine your purchase price for the shares. 

 

  • New Hire: Newly hired employees receive the shares based on the closing price on the date they start at the company. This is called the grant-date value (GDV). If the share price goes up, the shares will be worth more, but the amount of shares will remain the same. If the share price goes down, the shares will be worth less, but the amount of shares will remain the same. 

 

  • Existing Employee: If you are an existing employee, you will receive the shares based on the closing price on the date you exercise your options. This is called the exercise-date value (EDV). Like newly hired employees, if the share price goes up, the shares will be worth more, but the amount of shares will remain the same. If the share price goes down, the shares will be worth less, but the amount of shares will remain the same.

 

Know When to use RSUs

There are many factors to consider when deciding if an RSU program is best for your company and you as an individual. Different equity programs are appropriate for different companies and individuals, and you should take a close look at all the options before making a decision. How mature is the company? Is the company profitable? How fast is it growing? What stage of the company’s lifecycle is it in? These are just some of the important factors to analyze before deciding if an equity program is right for your company.

 

When and How to Tax Events for RSUs

Tax events occur at the time of an RSU vesting or when an employee exercises the option to receive shares. There are a few different ways to handle the taxation of RSUs, but the most common is the “with-and-without” method. With-and-Without Method - With the with-and-without method, the company calculates the amount of taxes owed when an RSU vests and when an employee exercises the RSU option. The employee is responsible for 50% of the taxes owed, and the company is responsible for the other 50%. Gross-up - Another option is to have the company pay the taxes owed at the time of the vesting or exercise. Net-of-taxes Method - A third option is to have the company pay 100% of the taxes owed on the RSU at the time of vesting or exercise.

 

Important things to know about RSUs

When considering if an RSU program is right for your company and you as an individual, it’s important to consider a wide range of factors. Here are a few to keep in mind. 

  1. Company Maturity: Before you accept an RSU offer, you need to know how mature the company is. This will help you understand the potential upside of the equity. The more mature the company, the more likely it is that the equity will be priced at fair market value. Newer, unprofitable companies often grant equity that is easily liquidated. 
  2. Company Profitability:  Another important factor is the company’s profitability. If a company is profitable, there is less risk that the equity will become worthless. Profitable companies are more likely to grant equity that is priced at a significant premium compared to the company’s current share price. 
  3. Company Lifecycle: The lifecycle of the company is also important to consider. The company’s lifecycle will help determine how quickly the company will be able to grow and how much value the equity could gain.

 

Drawbacks of RSUs

Like any equity program, there are certain drawbacks to be aware of. 

  • Company Performance - If the company doesn’t perform well, your equity award might not be worth anything. This is true with any equity program, but it’s especially important to consider this factor with RSUs because they are often granted to employees who are not part of the company’s core team. 
  • Vesting Schedule - A vesting schedule can be advantageous if the company is doing well and you want to wait to receive shares. However, it can also be a drawback if the company does not perform well and you don’t receive shares until the end of the vesting period.

 

Bottom line

Equity programs such as RSUs are an important tool for companies to attract and retain talent. Like any equity program, there are benefits and drawbacks to be aware of before accepting an RSU offer. The important thing is to consider your options and make the best decision for your career trajectory. When deciding if an RSU program is right for you and your company, it’s important to consider a wide range of factors. Company maturity, company profitability, and company lifecycle are just a few important factors to keep in mind. Visit Stockprices.com for more comprehensive information to help you succeed with your financial goals.