When it comes to employee compensation, many tech companies provide equity and stock-based benefits to their employees. The intention behind this kind of stock-based compensation is to align the performance interests of the employee with the employer. By granting ownership in the company to employees, employees then have skin in the game concerning the company's value, which encourages employees to take ownership of their work to increase the value of the company and thereby the potential financial rewards based on the company's financial strength. Though equity compensation is complex, and each type of benefit has its own set of rules, employees need to understand the nuances of each kind to effectively execute a proper strategy. One common form of equity-based compensation from publicly traded and late-stage private, VC-backed tech companies are restricted stock units (RSUs). Here's what you need to know about this form of equity-based compensation.
What Are Restricted Stock Units (RSUs)?
Restricted stock units (RSUs) are a promise from a company to deliver a certain number of shares of company stock to an employee when certain time-based or performance-based conditions are met.1 Time-based conditions could require that the employee be at the company for a certain amount of time or be subjected to a vesting schedule.1 Vesting schedules are designed to incentivize employees to stay with a company. A typical vesting schedule is around four years, meaning employees must stay that long before they have earned into the total value and benefit of their RSU grants.1,2 Further, performance-based conditions could include when a company goes public, when a company is sold or acquired, or when a company reaches specific growth and financial metrics.1 Until they are vested, RSUs hold no intrinsic value, yet once vested, the employee can access the stock just like any other stock they may own (so long as the company's stock is publicly traded). Their value is based on the fair market value of the stock at the date of delivery.1,2
With respect to late-stage private, VC-backed tech companies, RSU vesting will typically be subject to a "double-trigger" event. This means that employees must meet two requirements to vest into their RSUs: the time or performance-based conditions and a company liquidity event. The technical term for a liquidity event is a "change of control." What this means in practical terms is when a company goes public, or if the company is acquired, the liquidity event condition is met. Any RSU's vested under the time or performance-based requirements will vest all at once. Depending on how long an employee has been with the company before this event, this can cause a substantial amount of the RSUs to vest in any one year. While great from a wealth generation standpoint, this can cause significant tax issues that should be fully considered and planned around in the year of the double-trigger event.
Tax Considerations for RSUs
Put simply, RSUs are taxed like a regular paycheck. This means that upon vesting, the fair market value of the shares are subject to federal income tax, Social Security taxes, Medicare, and state/local taxes. You'll also be expected to pay the taxes upfront for tax withholding, though it is common to surrender a portion of the vested shares to cover the associated taxes. Though it is pretty standard for high earners for these tax withholdings to fall short of the ultimate tax liability caused by vesting into the RSU's, which can result in an unfortunate and surprising tax bill come tax day. Therefore, it's crucial to establish a few plan options ahead of time that takes tax and single-stock concentration risk into account when you are vesting into your RSUs.4 Remember, working with your wealth management and tax planning team is important to make sure you make the most of your RSU grants. They are complex and can have various financial and tax implications, so working with experienced guides as you navigate your equity compensation is invaluable.
What Happens to Your RSUs If You Leave a Company?
Job termination typically ends the vesting of RSUs immediately, though you will retain the RSUs that have previously vested. While stock options end the vesting schedule early and may require you to exercise your options shortly after leaving, there is usually no such provision for RSUs. You should review all documentation with your wealth management and tax planning team to ensure that you understand the ramifications of what equity compensation is offered or granted.4 Make sure to review the provisions for what would happen if you took a leave of absence, became disabled, or passed away while holding RSUs. If your RSUs transfer to a beneficiary, ensure that you have a beneficiary established with the stock plan administrator.4
Restricted Stock Units (RSUs) vs. Stock Options
It is pretty common for employees to confuse RSUs with stock options. Unlike RSUs, stock options let you purchase company stock at a specific price for a predetermined amount of time. Employees will most likely need to be vested into this option, but employees typically use their own funds to purchase company stock.1 However, many public companies offer the option for cashless exercise, which allows employees to tap into the value of their options without fronting the cash to exercise. Either way, stock options are functionally much different from RSUs and carry their own set of tax implications that employees should fully understand before implementing an exercise and divesting strategy.
At Faubion Wealth Management, we specialize in navigating these waters and have the wealth and tax strategy expertise to deliver customized solutions that maximize and optimize your equity compensation. If you have RSUs, or any type of equity compensation, and are curious about how to fit it into a holistic wealth plan and strategy, we'd love to have a conversation with you! Please reach out directly through the contact link below!
Matt Faubion, CFP®
Founder - Wealth Manager
This article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax, legal, accounting, and financial professionals if you want more information about restricted stock units.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.