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It seems more and more of the people that we work with are starting to receive restricted stock units (RSUs) as a part of their compensation. Minnesota is home to some of the largest Fortune 500 companies in the world, many of which have restricted stock units as a part of their equity compensation plan. So, we decided to write an article as a primer on restricted stock units.
Restricted Stock Units are a type of equity compensation that employees receive from their employer. Unlike traditional stock options, RSU's are not actual shares of stock but rather a promise to receive a specified number of shares in the future. This promise is conditional upon certain restrictions being met such as reaching a specified date or time in the future and potentially performance goals.
RSU's are becoming an increasingly popular form of equity compensation particularly in the technology sector. here are some key features of RSUs:
1. Grant date: On the grant date the employee receives a grant of RSUs which is a promise to receive a specified number of shares at a future date. Many employees may receive an RSU’s as a part of their signing bonus or annual compensation.
2. Vesting Schedule: RSU's usually vast over a period of time meaning the employee cannot sell or transfer the shares until the vesting period is over. While there are varying types of vesting schedules, a common schedule would be a four-year vesting period with a one-year cliff. This means that a person would not become eligible to receive their first shares until after one year of employment, and then the remaining shares would vest annually for the remaining three years. In essence this is essentially 1/4 of your shares being unlocked every year for four years.
a. I.E. 1,000 shares at your initial grant, with 250 shares vesting at the end of each year for four years.
3. Taxation: RSUs are taxed as ordinary income when they vest based on the fair market value at that time. Companies will often withhold a flat 22% for federal taxes, and the employee will likely net the share value after taxes. This can create an additional tax liability if the amount withheld is too little, additionally, taxes are often not withheld for state tax purposes, so if you live in a state with state tax this could increase your state tax liability.
4. Settlement: At the end of the vesting period the employee receives the actual shares of stock and can sell or transfer them as they wish.
RSU's have several advantages over traditional stock options. One advantage is that they are simpler to understand as employees do not need to exercise their options in order to receive the shares. RSU's can also be more predictable as it relates to your cash flow since regardless of the share price you should receive some value in your stock assuming that the company does not go bankrupt. Another advantage is that you do not have to exercise and purchase the shares like you would with incentive stock options or non-qualified stock options.
However, there are also some disadvantages to RSU's. one disadvantage is that the employee cannot sell or transfer the shares until the vesting period is over which can limit their flexibility. Another disadvantage is that the employee may receive a large tax bill when the RSU's vest which can be difficult to pay if they have not saved up enough money.
to wrap it all up, RSU's are a popular form of equity compensation that can offer employees a valuable benefit in the form of company stock it is important for employees to understand the key features of their RSU's and to carefully consider the pros and the cons before accepting a grant of RSU's. At Tilli Wealth Management we handle RSUs on a weekly basis and have the expertise to help our clients navigate this complicated topic.
Sources: https://www.wallstreetprep.com/knowledge/restricted-stock-units-rsus/
https://www.investopedia.com/terms/r/restricted-stock-unit.asp
https://www.schwab.com/public/eac/resources/articles/rsu_facts.html
