635 Mariners Island Blvd Suite 204, San Mateo, CA 94404 +1 (650) 262-6670[email protected]
Stock Options vs RSUs
Pros and Cons of Restricted Stock Units (RSUs)
Pros and Cons of Restricted Stock Units (RSUs)
RSU Pros:
an RSU is never under water
There is no exercise price for the employee to purchase. They get the whole value of a stock equivalent for free. As such an RSU is never under water.
Companies that care about reporting earnings can take a more predictable hit to earnings than they would with options.
Companies have a clear sense for how to grant fairly between employees arriving at different times. E.g. a particular job title might budgeted for $100k in RSUs. The number of RSUs to grant would simply be $100k divided by the current FMV.
RSU Cons:
An RSU will always be taxed at the high ordinary income tax rates upon vesting.
An RSU will always be taxed at the high ordinary income tax rates upon vesting. An exception is filing an IRS 83(i) election to get a 5 year deferral. Ordinary income tax will still be due on the RSU value but additional increases in value are eligible for capital gains treatment.
They don’t vest until liquidity is achieved but the date of the IPO or M&A event is out of your hands. Meanwhile, RSUs typically expire within 5 to 7 years and companies are not obligated to reissue them.
An RSU cannot be sold or transferred while the company is still private.
RSUs are not eligible for filing an 83(b) at the time of grant to lock in lower taxes. As such, you are stuck paying the high ordinary income tax rates at the time of share delivery regardless of whether you are ready to sell.
An IPO triggers taxes for RSUs even if you aren’t ready to sell the shares. However, you can either file an 83(i) to defer taxes or sacrifice a portion of the shares to cover taxes.
Post IPO vesting causes your tax bracket to explode to higher levels regardless of whether you sell the RSUs. This means that even your regular W2 wages will get taxed at a higher rate. If you are turning in shares to cover taxes, you have to turn in more shares than usual.
For companies where employees are turning in shares to cover taxes, the company still has to send real money to the IRS as opposed to shares. This is a very poor use of IPO share selling proceeds that usually has to be disclosed in the IPO prospectus.
Companies don’t get the retention benefit associated with options that have to be exercised. If a company grants large blocks of RSUs at an early stage because they seem cheap, they might make employees who don't care about taxes happy but it could ruin the company. These employees can quit even after one year and hold the RSUs a long time. Subsequent employees won't get nearly as many shares because of the rise in value but will have to do most of the work getting the company through the 8+ years the average good company requires to exit. The early departures will get most of the benefit and that won't be fair. Even worse, if the number of departures is large, it will dilute the cap table and discourage investors and encourage restructuring which invites lawsuits. Just bad all around.
