Restricted Stock Unit (RSU)

Introduction to Restricted Stock Units (RSUs)

Pre-Read: Key Questions This Article Answers

• What are restricted stock units (RSUs)?

• Do I need to exercise my RSUs?

• What is the difference between and single- and double-trigger RSU?

• What are the pros/cons of RSUs?

What Are Restricted Stock Units (RSUs)?

RSUs are one of the most common types of equity compensation granted to employees. They’re most commonly granted in (i) late-stage Pre-IPO companies and (ii) Publicly Traded Companies.

RSUs grant an employee a specified number of shares of company stock over a period of time. The shares are tied to a vesting schedule, wherein the employee functionally earns a portion of the shares periodically (usually monthly or quarterly).

How RSUs Work/Key Components

Number of Shares

RSU grants specify a number of shares that you vest into over time (e.g. 10,000 shares vesting quarterly over 4 years). This is one of the two key components that determine the value (shares * price per share = hypothetical dollar value)

CLARIFICATION: RSU grants specify a number of shares you will vest into, not a dollar amount. This gets confused at times because most companies target a dollar amount (a function of an employee's role, seniority, performance, etc) when determining the number of shares for an RSU grant.

Vesting Start Date

The vesting start date is exactly as it sounds -> the date the vesting begins.

• For new-hire grants, vesting typically starts on the employee's start date.

• For existing employees (getting new/additional grants), the vesting start date can vary but is usually somewhat close to the grant date.

Vesting Schedule

The vesting schedule determines when an employee receives ownership of a portion of the shares. The key sub-parts of this are: (1) Vesting Start Date; (2) Total Length (e.g. 4 years); (3) Vesting Frequency (e.g. Quarterly); (4) Cliff or No Cliff; (5) Any Other (Less Common) Items

IMPORTANT: Vesting schedules can (and frequently do) vary in many ways. For more information and examples see: Vesting Schedules

Single-Trigger vs. Double-Trigger RSUs

RSUs are most frequently issued by publicly traded companies and late-stage Pre-IPO companies.

• For a publicly traded company, all RSUs will be “Single-Trigger”

• For a Pre-IPO company, RSUs are likely to be “Double-Trigger”

Single-Trigger RSUs

Single-trigger RSUs Are Relatively Straight Forward:

• When the date a specified number of shares vest, the employee gets those shares (less any shares the company auto-sold to cover withholding taxes)

• As long as the individual remains employed, they'll continue to receive the scheduled amount of shares on each subsequent vesting date

Note: 25% tax withholding is used as an example. The actual percentage a company will withhold depends on your year-to-date earnings and the state tax rate.

Double-Trigger RSUs

Double-trigger RSUs are more complex. When the date a specified number of RSUs vest, the employee only gets those shares if both ("double-trigger") requirements have been met:

• (1) the vesting period/date must have been met, and

• (2) an exit/liquidity event (e.g. IPO, acquisition) must have also occurred. (For Pre-IPO companies, it may take many years for this requirement to be met)

Why the complexity; and how is this “good” for a Pre-IPO employee? In short, tax implications:

• When single-trigger RSUs vest, it triggers income taxes (and a tax withholding requirement). As a pre-IPO company, there is no liquid market to sell the shares--> so the company has no means of generating cash for legally required tax withholding. And many employees would not have the funds to pay out of pocket (nor would many want to).

• To solve this, a "second-trigger" is added. The second trigger specifies that shares don't formally vest unless both criteria have been met-->and as such no taxable event has occurred. This is ideal for a Pre-IPO company whose shares are not liquid/don't trade daily.

• Note: time-vested shares "accrue". If/when the liquidity event requirement is met, all the previously time-vested shares will formally vest

Cliff Vesting ("Cliff")

Cliffs are a common feature of RSU grants, especially for new hires. A cliff is built into the vesting schedule, functionally modifying it so that no RSUs will vest until a minimum amount of time is met (i.e. the cliff time period). For new hires, a 1-year cliff is very common.

Why do companies use cliffs? Stock-comp is intended to incentive employees to add value to a company. Cliff's help ensure a long enough tenure to add such value.

For example, let's say a new employee gets a 4yr, monthly vesting RSU -- and then leaves the company after 3 months. Their value-add to the company is likely minimal, perhaps even negative (given they were being trained in the first 1-3 months):

• With no cliff. The employee would have vested into 3 of 48 months

• With a 1-year cliff. The employee would not have vested into any shares

Vesting Schedule (With Cliff)

Vesting Schedule (No Cliff)

Expiration Date

• Single-trigger RSUs don’t have expiration dates (because the shares vest when the specified date occurs).

• But double-trigger RSUs do have expiration dates; typically around 7 years after the grant date. The plan and intent is for a liquidity event to occur prior to the expiration date (as the time-vesting component would have been met prior to the expiration date)

How RSUs Provide Employees With Value

With RSUs, employees receive actual company shares after vesting requirements are met. Unless the company becomes insolvent, these shares will retain some value that can be realized by selling the shares. And if the company does well, the value of an RSU grant should rise in tandem with the increase in the company stock price.

Value Creation: Pre-IPO

• Pre-IPO, RSU value realization depends on a liquidity event.

• There is not a liquid market for private company shares. Employees very likely cannot sell shares until a liquidity event (e.g. IPO, acquisition, or, in some cases, a tender offer) occurs.

• If/when a liquidity event occurs, the vested RSUs shares can be sold. Value can be realized via the sale of the position.

Value Creation: Publicly-Traded Companies

• For Publicly-Traded Companies, value realization will typically occur quarterly. When RSUs vest, employees directly receive company shares that can be sold on the public market.

• The value of your RSUs will change daily. Public company stock prices change daily and, as such, so will the value of your RSUs

• Reminder: A portion are force-sold by the company to cover withholding tax requirements, and the employee is free to hold or sell the remaining shares.

You do not purchase your RSU shares. With RSUs, you receive actual shares of company stock when the grants vest. There is no purchase required.

This is different from stock options, where employees have the right to purchase a specified number of shares at a fixed price.

RSU Benefits, Drawbacks, and Less Common Elements

Key Benefits

• RSUs have no out-of-pocket cost. You are granted the RSUs and upon satisfying the vesting requirements you receive a portion of the granted shares.

• RSUs will typically yield more value than ISOs/NSOs if the company's performance is underwhelming. If the stock price drops, vested RSUs will still provide some value due to representing ownership of actual shares. Whereas with options, a declining stock price would likely make the options "underwater" and therefore worthless.

• RSUs provide the opportunity to share in a company’s success. If the company stock appreciates significantly, the value of employee RSUs increase as well.

Flags/Drawbacks

• RSU grants typically have fewer shares than ISOs or NSOs. Employees are typically granted fewer RSUs compared to stock options (ISOs/NSOs) since RSUs do not require employees to pay to exercise/buy shares. This frequently means less potential upside if the stock price grows substantially.

• For private companies, RSUs will be illiquid and likely subject to a double-trigger. Employees may need to wait years after time-vesting shares before the shares can be sold and converted into cash.

• If RSUs are double-trigger RSUs, the individual likely will not be able to participate in a tender offer (should the company have one). A tender offer is not a specified liquidity event for the double-trigger requirement. As such, the RSUs will not have been formally vested to an employee. They thus do not technically own any shares to be able to sell.

• In rare cases, RSUs may create phantom income for private/pre-IPO companies. When RSUs vest, employees owe income tax on the value of the shares that vest.

  • If RSUs are (i) single-trigger and (ii) for a Pre-IPO company --> vesting will create a phantom income situation (where you owe taxes, but no cash flows came to you) and require you to pay cash out-of-pocket to cover the tax withholding.

  • In select situations, double-trigger RSUs can also create phantom income. For example, if your company has an IPO but does not allow you to sell shares in the IPO or for the next 6 months after ("a lockup"). The IPO event met the second trigger--resulting in taxes being due--but you don't have the ability to sell the shares (e.g. what happened to employees with Uber's IPO).

Less Common Elements

• Performance Hurdles restrict shares from vesting until certain metrics, such as revenue run rate targets, are achieved. These performance hurdles must be satisfied for vesting to occur.

• Clawback Provisions allow the company to reclaim vested shares or their cash equivalent if certain conditions are not met. These conditions might include the employee leaving the company within a certain time frame after vesting or engaging in misconduct that causes significant harm to the company.

• Non-employee grants are granted to non-employee service providers, such as consultants, advisors, or board members. The terms and tax implications for non-employee RSU grants may differ from those with employee grants.

RSU Tax Implications

• Ordinary income upon vesting. When RSUs vest, the employee receives shares of stock in the company. At that time, the fair market value of the shares is considered ordinary income to the employee and subject to income taxes.

• Tax withholding is required upon vesting. Your company is required to withhold income taxes from employees' paychecks (and will likely auto-sell a portion of your vested RSUs to cover this requirement).

• If RSUs are not sold after vesting, future gains (losses) will be taxed as capital gains (or losses). Once the shares are received and taxes are paid, any future gains in the stock price are subject to capital gains taxes if/when the shares are sold. For more information about RSU taxation see: RSU Taxation

22-30% of RSUs will likely be sold the day they vest. Nearly all companies will automatically sell a portion of your RSUs when they vest to meet IRS/State tax withholding requirements.

Related Pages

🔗 RSU Taxation

🔗 RSU Planning/Strategy

🔗 Vesting Schedules