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What is a Restricted Stock Unit?

definition

Restricted stock units are an employer’s pledge to give an employee shares of the company’s stock (or the cash equivalent) at a future date or once a performance milestone is met.

🤔 Understanding restricted stock units

Companies often want to reward employees — especially executives — who stick around and perform well. One way they can do this is by issuing restricted stock units (RSUs). RSUs are the company’s pledge to issue a certain number of shares (or an equivalent amount in cash) in the future. RSUs have no value when they’re issued. Unlike for stock options, an employee doesn’t pay to turn them into company stock. RSUs vest, or become exercisable, when the employee stays with the company until a given date, hits certain performance targets, or both. Once RSUs vest, they turn into regular company shares.

example

In 2018, the year after he took over as CEO of Uber, Dara Khosrowshahi received two sets of restricted stock units as part of his compensation package. The first set was scheduled to vest in four chunks spread over the next four years. The second set would vest in 2021, with the value of the RSUs dependent on certain milestones, such as the company going public (which it did in 2019), revenue growth, and an improved safety record. The second set of RSUs could also vest at any time if the company’s value reached $120B for 90 consecutive days after Uber went public (it didn’t go beyond $52B in company’s first six months on the market). The vesting of all of the RSUs depended on Khosrowshahi remaining the CEO of Uber continuously. The RSUs are an incentive for him to stay with the company and steer it toward strong performance. Source: Uber April 26, 2019 S-1/A Filing.

Takeaway

Restricted stock units are like IOUs with fine print...

RSUs have no value until they vest, but if you stay with the company for an agreed-upon amount of time and/or meet performance milestones, you will be rewarded with company stock.

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Tell me more...

What’s the difference between RSUs and stock options?
What’s the difference between restricted stock units and restricted stock?
What are the pros and cons of RSUs?
How is RSU value calculated?
How do investors decide when to sell shares from RSUs?
How are RSUs taxed?
Do only public companies offer RSUs?
What happens to RSUs if you retire or are incapacitated?

What’s the difference between RSUs and stock options?

Restricted stock units and stock options are both forms of non-cash compensation that companies use to create incentives for employees. Both involve waiting in order to get the value of the award. Stock options give recipients the right to buy company shares at a fixed price on a certain date. If the stock goes above this fixed price, that can mean a nice windfall for the owner of the option. But if the stock goes below that fixed price, that can mean the stock options become worthless. RSUs, on the other hand, always have some value — so long as the stock price doesn’t hit zero. Unlike with RSUs, employees might have to pay to turn their stock options into cash. If your company offers stock-based compensation, you typically don’t get to choose whether you get RSUs, options, or something else — It depends on your position, as well as your company’s size, phase of growth, and preferences.

What’s the difference between restricted stock units and restricted stock?

Restricted stock is yet another type of equity compensation (or compensation based on stock awards rather than cash). Restricted stock units and restricted stock may sound similar, but they’re different animals — particularly with regard to tax treatment. What the two vehicles have in common is that employees usually don’t have to pay to get them and — as the names suggest — they both come with restrictions.

One difference is that restricted stock actually transfers to the recipient on the grant date, while RSUs are a promise for the stock to be transferred in the future. Restricted stock is actual stock that the owner can’t sell until the shares vest on a certain date. It often comes with other conditions, such as the company being able to buy back any restricted stock that hasn’t vested if the employee leaves, or the company or employee hitting performance targets. Restricted stock usually vests over several years.

Outside of these caveats, owners of restricted stock are just like any other shareholders — They have voting rights and can get dividends (which is the set sum that some companies pay regularly to shareholders out of their profits). Since RSUs are not actually stock — just the promise of stock at a later date — holders of RSUs can’t vote or get dividends until the RSUs vest. However, sometimes companies choose to pay cash equal to the dividend amount to RSU holders.

Another big difference has to do with taxes. By default, both RSUs and restricted stock are taxed as ordinary income when they vest, not when they’re awarded. However, owners of restricted stock have the option to make a so-called 83(b) election, named for the relevant section of the Internal Revenue Code. This allows them the option to pay taxes on the restricted stock when it’s granted, instead of when it vests. Assuming the company’s stock price will go up in the future, this election can reduce how much an employee owes in taxes. Owners of RSUs don’t have this option, so they’ll end up paying higher taxes in the future as long as the company’s stock price rises.

What are the pros and cons of RSUs?

For an employer, restricted stock units have the benefit of motivating employees without the firm having to spend more cash immediately. Compared to other stock-based compensation, they have the advantage of keeping administrative costs low, since the company doesn’t have to record transfers of actual shares. Plus, the company doesn’t have to issue shares immediately, which helps existing shareholders maintain more control of the company for longer.

For employees, RSUs are a reason to stay with the company and do their best to help it do well, so the shares gain value. Unlike with stock options, employees don’t have to pay to get the benefit — nor does the employee bear the risk if the share price falls below the strike price (the price at which the owner of options has the right to buy shares). RSUs will always have some value once they vest, even if the stock price plunges, unless it actually hits $0. The downside is that employees don’t get dividends or voting rights until the RSUs vest. Also, their equity compensation gets less favorable tax treatment than if they had been issued restricted stock. As noted above, owners of restricted stock have the option to pay taxes when they receive the award, not just when it vests. This reduces their tax liability, as long as the company’s stock price goes up. The employee may also have to give up some or all of the expected shares if he or she quits, gets laid off, or gets fired, before the vesting date. That risk does not exist with cash compensation or stock awards without restrictions.

How is RSU value calculated?

The fair market value of restricted stock units (which will be used for your income taxes) depends on the company’s stock price when they vest and you receive the shares. The way this value is calculated differs by company, so an employee will want to check the rules in his or her employer’s plan. It can be based on the stock price on the close of the previous business day, the real-time price, the closing price on the day you get the shares, or average high and low prices for the day. Let’s say you have 100 RSUs that vest today and your company values them based on yesterday’s closing price. If shares were worth $50 apiece when markets closed yesterday, then you essentially receive shares worth $5,000. Most RSU plans require issuing stock, but some allow a cash payment instead.

How do investors decide when to sell shares from RSUs?

You can typically sell your shares as soon as your restricted stock units vest. In some cases, companies may have policies limiting trading, such as only letting you buy or sell during certain periods. Deciding to hold onto the shares, rather than sell them, is basically the same as deciding to buy company stock at the going price. When deciding whether to sell, you might want to consider whether you expect the stock price to continue going up and whether you need cash in the near future. You may also want to think about what percentage of your assets is in company stock — Many financial advisors suggest diversifying your holdings to reduce risk in case the company hits a rough patch. The tax implications of receiving and selling shares are another consideration.

How are RSUs taxed?

Restricted stock units aren’t taxed when you first get them — Since they’re IOUs and not actual shares, the government doesn’t consider them income. Once your shares vest, the Internal Revenue Service treats the fair market value of the shares you receive as ordinary income, which is any income taxed at regular rates, such as your salary or a cash bonus. You may also be responsible for paying state and local income taxes on the shares that year, depending on where you live. Often, you can decide to have your company withhold some of your shares as a way of paying income taxes. The amount withheld depends on the value of your shares as well as the tax withholding rate your company provides.

If you decide to sell any shares, you could be subject to capital gains tax, which is charged based on profits from selling an investment or property. The tax you pay will depend on the difference in the value of your shares when you sold them, compared to when you received them. If you sell them immediately, they probably won’t gain much value, so you may not have to pay much in capital gains tax. Keep in mind that if you sell in less than a year, you’ll pay short-term capital gains tax — which is the same rate as your tax bracket — on your profits. If you wait more than a year, you’ll pay between 0% and 20% on any gains, which is usually a lower rate than the short-term tax. If the stock has lost value when you sell it, you can use that loss to offset taxes on profits from other investments.

If your company paid you dividend equivalents for your RSUs before they vested, that is simply reported as wages on your W-2. That means you’ll be paying a higher tax rate on them than you would have on qualified dividends (between 0% and 20%), which are those paid by companies that meet certain government requirements.

Do only public companies offer RSUs?

Public companies are the most likely to issue restricted stock units, along with other types of stock-based compensation. Private companies that plan to go public soon also frequently use RSUs, but you usually need to wait for the initial public offering to happen in order to cash in. Private companies with no plans to go public rarely offer RSUs.

What happens to RSUs if you retire or are incapacitated?

The rules on what becomes of your restricted stock units if you retire, die, or become disabled differs by company. Check your employer’s plan to understand what to expect if the worst happens. The rules might be different for vested and unvested RSUs. 20191127-1023960-3085491

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