Restricted Stock Unit

What is a restricted stock unit?

A restricted stock unit (RSU) is a type of stock-based compensation awarded to employees to show appreciation for their performance and tenure in a company. This compensation transforms into common stocks at the end of the vesting period. 

A vesting period is a time period an employee needs to work at a company to activate their share ownership and earn the right to present or future payment, asset, or benefit. Activation might also occur upon achieving a particular milestone. 

RSU has no financial value unless employees hold them throughout the vesting period. Initially, restricted stock units act as a promise companies make to share a part of their economic growth at the end of the vesting period. 

RSUs are assigned a fair market value and are considered a part of income once vested. Fair market value is the property’s value as determined by a marketplace or purchasers rather than as calculated by a subjective individual. A  portion of these shares is withheld to pay income taxes. An employee gets the remaining amount and has the option to sell them.

Many businesses use benefits administration software to manage and track employee benefits such as stock options, restricted stock units, and insurance plans while facilitating effective compliance audits. This software usually comes with an employee portal and self-service features that enable employees to update their information. Employers use these programs to manage and modify employee benefits packages. 

Types of restricted stock units

RSUs can have multiple restrictions. Some have only one condition, such as a vesting period.  Others might have additional requirements to gain financial value from restricted stock units.

Below are the two types of restricted stock units that employers usually offer. 

• Single-trigger RSUs have one condition, such as a vesting period that should be fulfilled to add financial value to grants. For instance, an employer grants 800 RSUs to an employee, the vesting schedule is 50% after one year of service, and the remaining 50% after completing two years in the company. After one year of service, the employee has 400 shares, and the other 400 are awarded to them at the end of their second year in the company. Employers can also use cliff vesting, in which all shares are awarded at the end of the vesting period, which is two years in the above example.
• Double-trigger RSUs have more than one condition to be fulfilled to drive their financial value. Often, the first trigger is the vesting period. The subsequent triggers can be performance or milestones such as product launch, merger, acquisition, or initial public offering.

RSU example

Suppose an employer of a publicly-traded company awards 500 RSUs to an employee when they join. The market values these shares at $10. The employer admires the skillset of their employee and thinks they would be an excellent value add to the company. The company establishes a vesting period of five years and a schedule of releasing 20% of the total RSU each year in the employee’s account. 

The employee will have 500 shares in their account when they complete five years at the organization. If the employee leaves the company in one year, they’ll have 100 shares and will have to forfeit the other 400. 

Suppose the employee stays in the company for five years, and the market value of each share rises to $20. The employee will be eligible to receive 500 shares with a financial value of $10000. However, the employee will have to pay tax on this income, or the employer may hold some shares to pay off the income tax. 

How to sell RSUs

Selling RSUs at the end of the vesting period depends on whether the company is public or privately held. Here’s how employees can sell their shares in both situations:

• Private company: Selling RSUs in a privately-held company can be tricky due to the unavailability of a marketplace. Employees might need to wait for a liquidity event such as mergers, acquisitions, or initial public offerings. These liquidity events allow employees to sell their shares while funding their tax liability. On the contrary, if employees see an exponential growth trajectory, they may choose to hold the shares and cover taxes out of their own pockets to enjoy significant capital gains in the future.
• Public company: Selling RSUs in a publicly-traded company is comparatively easier as there is a readily available marketplace. Employees can sell their RSUs anytime if they’re satisfied with the shares’ current market value. Employees may decide to sell their shares to fund other financial goals or hold them for a long time to qualify for long-term capital gains and save on tax. 

Benefits of restricted stock units

Below are some benefits of RSUs over other employee benefits, such as stock options and more.

• Simple rules to understand. RSUs are easier to understand as they lay out a schedule for employees to receive them. It clears up any confusion on the timeline, vesting period, and the value of shares, and explains conditions that need to be met for RSUs to hold financial value. 
• Fewer decisions to make. Stock options come with complicated decisions such as when to exercise them or what exercise method to use. This makes it tricky for employees to transform these options into financial benefits. On the contrary, RSUs come with a fixed vesting period or milestones, and upon completion, employees get the shares. Employees can hold or sell them based on their preferences.
• Fewer risks to take. Restricted stock units have value at vesting regardless of any changes in the company’s stock since the grant. The value of stock options depends on whether a company’s share price has appreciated or depreciated on the market. Usually, a stock options grant involves more shares than restricted stock units. However, there’s a possibility that stock options’ value might be underwater at the time of vesting or for the remaining option term.
• Flexible to hold or trade. When employees vest RSUs, they can keep them even when they decide to move from a company. This provides more flexibility, especially in the case of a publicly-traded company. These shares can be used for other investment purposes, funding retirement, children's education, or paying off debts. 
• No requirement to purchase. Employees don’t have to buy RSUs at a certain price; the units are their own upon vesting. On the flip side, stock options grant employees the right to purchase shares at a certain price, often called strike price or exercise price.

RSU Taxation

On completion of the vesting period, RSUs are delivered to an employee’s account. These shares are taxable, where the taxable income is the market value of a share at the end of the vesting period.

 For non-US employees, the RSU taxation timing is similar, and state and social taxes depend on the current market value of the shares. 

Stock options vs. RSU

Stock options give employees the right to purchase a company’s share at a particular price and time. A certain number of shares can be made available every year to purchase based on a vesting schedule.

Stock options are a popular benefit offered by early-stage or high-growth startups and come with greater potential for value appreciation. 

On the other hand, a restricted stock unit (RSU) conveys an employer’s promise to grant a certain number of shares to an employee after a specific period or after achieving a milestone, without any upfront payment. 

Restricted stock units are generally awarded by later-stage or more mature companies and come with less risk.