In recent years (actually, since Facebook), it has become increasingly popular for private companies to issue restricted stock units (“RSUs”) in lieu of stock options or other stock compensation. Here, we check off the most important things you need to know to understand MSW.
1. WHAT ARE RSUS?
An RSU is an allotment of shares valued in terms of ordinary shares to be delivered at a future date. Following the award (see below), the company will deliver shares of its ordinary shares to you. Unlike options, it does not matter what the value of the RSU is on the grant date. So, for example, if the company issues you 10,000 RSUs, its value, for all intents and purposes, is determined at the time of consolidation (price per share at the time of consolidation X 10,000).
2. HOW TO MAKE THE RSUS VEST?
RSUs can acquire vested rights in various ways, at the company’s discretion. However, it is often not the standard purchase program associated with options (4 years with a 1-year “cliff”). It is common for RSUs in private companies to be granted upon satisfaction of (i) a service condition and (ii) a performance condition. The service condition requires you to work with the company for a certain period of time, often 4 years (although the “cliff” period may still be one year) to fully award your award. The performance condition is linked to a liquidity event in the company: its initial public offering or its acquisition by another company.
3. LET’S TALK ABOUT TAXES, BABY.
There is no taxable income on RSUs at the time it is awarded, because you have not received any shares yet. At the time of the award, you will receive shares at the fair market value (FMV) at the time of the award. This is considered compensation (not simply income, so it is subject to withholding) in the year of consolidation and is taxed at the ordinary income rate. For example, let’s say you were awarded 100 RSUs. Upon award, you would receive 100 shares of the company at fair market value; Let’s say this is $ 10 per share. One drawback to note here is that companies often “sell to hedge,” meaning they will sell enough shares to cover the hold and then issue the balance. Therefore, you can receive 80 shares once this is done, with a basis of $ 800. Your W-2 for the vesting year would show an additional compensation of $ 1000, with $ 200 in additional withholding.
Your holding period for the 80 shares would begin on the issue date, which is usually (but not always) the acquisition date. For example, Twitter RSUs are issued within 30 days of award. When you sell the shares, it is taxed like any other sale of shares (subject to capital gains and losses).
4. HOW IS RSUS DIFFERENT FROM OPTIONS?
There are some key differences. First, unlike an option, there is no strike price. So a MSW will always have value (it can never be “under water”). Second, the tax treatment is very different. RSUs are taxed as soon as they are consolidated and issued. Options are not taxable until exercised (they can be consolidated before they are exercised), and even then, in many cases, incentive stock options have no tax impact when exercised.
5. WHY WOULD A PRIVATE COMPANY GIVE ME RSUS AND NO OPTIONS?
RSUs tend to be all the rage amongst the unicorn ensemble. You really only see them with highly rated later stage private companies (Twitter, Facebook, Dropbox). At first glance, it doesn’t make sense for a company to issue RSU to its employees because they don’t align the incentives. Unlike options, an employee who receives RSU will receive value regardless of whether the company appreciates in value. So why have unicorns gone the RSU route? When you have just raised a round of financing with a valuation of $ 1 billion, the exercise price of the future options written will be quite high. It may take some time for the company to achieve its valuation, diminishing the value of the options in the eyes of the holder. Simply put, astronomical valuations make it difficult to recruit talent due to the impact on the exercise price of options.