Author: Jillian Climie.
In my last article I wrote about my belief that a lack of understanding of equity compensation is contributing to the gender pay gap, where women still earn only 84% of what men earn. When a company performs well, equity compensation can lead to significant gains for employees, often well beyond base salary or bonus compensation. I believe equipping women with a better understanding of how equity compensation works will enable them to feel confident in negotiating for more. This will in turn enable women to participate in these upsides.
I previously described what stock options are and how they work, which are one of the more confusing types of equity compensation. In this article, I am going to describe restricted stock units.
Restricted Stock Units (RSUs) 101
RSUs are in my view the most straightforward type of equity compensation. Essentially, your employer is granting you shares in the company. However, these can either be real shares (meaning you will receive actual shares of the company) or notional shares (meaning you will receive a cash amount that tracks the share price of the company).
RSUs are different from stock options in the sense that you personally have to action stock options in order to have shares in the company, whereas with RSUs you automatically receive them (or the notional cash value). However, they still are typically subject to a vesting period over multiple years, which means they do not actually become yours until they “vest” at a future date. Lastly, RSUs are typically much easier to value than stock options – one unit is equal to the value of one share.
Example: 3,000 RSUs were granted to you on January 2, 2022 when the company share price is $10. This means the RSUs are worth $30,000 (3,000 x $10 = $30,000) at that point in time. One-third of the RSUs vest on each of the first, second and third anniversary dates of the grant, meaning they vest over three years in total.
On January 2, 2023, one-third or 1,000 units of the RSUs vest when the share price is $20, so their value is $20,000 (1,000 x $20 = $20,000). This means:
a) If you were granted real shares, you can now choose to do what you want with the 1,000 units that are worth $20,000. If your company is public, you can sell all or a portion of them on the market and take home that cash (excluding tax considerations), or you can choose to hold them longer if you think the share price will keep increasing. If your company is private, you may not be able to sell them, but you now have real ownership in the company.
b) If you were granted notional shares, you now have access to the $20,000 worth in cash (excluding tax considerations).
The remaining 2,000 units are not yet yours because they have not yet vested. On January 2, 2024, and January 2, 2025, if you are still employed, you will get access to each of the remaining 1,000 units – which vest in the same way as the example above.
Some Notes & Tips:
These notes and tips explain at a high level some of the technical aspects and considerations of RSUs, to help familiarize you with key terms and concepts.
Risk profile: RSUs are a relatively lower risk, more stable type of equity compensation as they will always have value as long as the share price is above $0 (whereas stock options will only have value if the share price is above the grant price). For example, if you were granted 1,000 RSUs at $10 (i.e., a value of $10,000) and the share price decreases to $5, they are still worth $5,000. Understand the risk profile when deciding what type of equity to negotiate for.
Vesting period: RSUs most commonly vest over three years, but there can be shorter or longer vesting schedules depending on the intent and structure of the grant. Know that sometimes RSUs can be “back-loaded”, meaning their vesting is more heavily weighted to the end of the period (e.g., 20% vests in year 1, 20% vests in year 2, 60% vests in year 3). Ensure you know the vesting schedules of any units you receive so you can understand when you will actually see value from them. Note if you leave your employer before a portion of the grant vests, you typically forfeit that amount. This is intentional as RSUs are designed to retain you over the long-term.
Actioning: when you are granted real share units in a public company, once the RSUs vest, you do not have to sell them right away. If you believe in the company, you can choose to hold the shares over the longer term and sell them at a future date (with hopefully a higher share price).
Restricted stock awards (RSAs): you might come across RSAs instead of RSUs. The main difference between the two is that RSAs typically enable ownership of the stock right when they are granted, whereas RSUs are not owned until a future date. However, RSAs can still have vesting periods which govern what happens to the units if you leave the company or are terminated.
Plan text & equity agreements: when joining a new company or negotiating compensation with an equity component, I recommend looking up the equity plan text (if the company is public) or requesting the RSU agreement. Although RSUs are relatively simple, it is still important to understand key design features. For example, if your employer is private, what happens to the RSUs if it goes public or if there is a change in control? If your company is public, what happens if you retire or take a leave of absence? Employees are often surprised by the retention features of equity, so ensure you understand them up front, and any differences if you are comparing job offers.
Tax: taxation of RSUs can differ based on where you are located geographically, if your employer is public or private, and if you are getting real or notional shares. While there are many nuances, RSUs are often taxed when they vest, meaning you cannot time the taxable event. Additionally, they can be taxed again when you sell the shares as capital gains. Overall, it is important to understand when the taxable events are, and what the taxation is (i.e., employment income or capital gains). Money will often need to be set aside for taxes at the end of the year, so ask an expert if you anticipate making a material amount from equity compensation.
While RSUs are one of the simpler forms of equity compensation, it is still important to understand their nuances. They can be made more complex when performance conditions are added to them, which effectively turns them into performance stock units (or “PSUs”). I will dive into those in my next article – and please feel free to reach out if you have any questions in the meantime at contact@thethoughtfulco.net.