By Bernard Williams
One of the biggest challenges you face as a business owner is how to motivate and retain employees. It’s a multi-dimensional equation. Every employee is unique. But, when it comes to stock options and equity sharing, one of the most popular ways to keep the team motivated is by granting Restricted Stock Units (RSUs). This article provides an introduction to RSUs, their benefits, and a brief overview of RSU tax consequences.
No question about it, RSUs are incredibly popular, not only among startups and early stage firms, but even among the big players. In 2016, for instance, Apple announced an RSU benefit to its Apple Store employees. Microsoft, Amazon, Facebook and Google also include RSUs in their compensation packages.
What’s An RSU?
An RSU is stock that’s only available at a future date. It is therefore considered deferred compensation. RSUs are typically distributed with a vesting plan on a schedule. In almost all cases, the plan specifies that an employee must achieve a certain performance target within a period, four or five years, for example.
RSUs have forfeiture rules. The employee loses rights to the shares if he or she leaves the firm prior to the completion of the vesting period, or hasn’t reached the performance goals.
One of the most compelling aspects of an RSU plan is that it’s granted at fair market value. Compared to a stock option, an RSU can be accepted without purchasing it. It is simply a promise of future compensation, nothing more.
Keep in mind that the RSU has no real value until it vests, which is typically defined by an event such as an IPO, or upon the achievement of the performance targets. And, since the RSU holder doesn’t actually own the shares, he or she retains no voting rights and isn’t subject to dividends.
The truly compelling aspect of an RSU is its fair market value – only after vesting. And, att that point, it’s considered taxable income. In most scenarios, the company withholds a portion of the RSU grant to cover the employee’s income tax on the stock value.
Summary of Benefits
- The number one benefit of the RSU is that the stock is owned by the employee without purchasing it.
- Unlike a stock option, which vests at a predefined stock value, the RSU is vested a full share value. Stock option shares require an increase in value before they are of any financial benefit.
- There are administrative benefits. Since it’s only a promise of a grant, it eliminates proxy voting, canceling shares if an employee leaves, and keeping track of the shares in custody. And there are no cash dividends to deal with.
- They can be set up with a deferred tax liability so that tax isn’t paid until vesting. Note that there are important differences between an RSU and a restricted share grant. So, be sure to get acquainted with these nuanced tax implications before granting them.
Important Things To Know
Employers and employees need to be aware of the following prior to entering into an RSU based compensation plan:
- Get very clear about the tax consequences and tax withholding.
- Know the consequences if the employee is laid off, resigns, or retires.
- What is the precise definition of the vesting event? An IPO? Length of employment? Hitting performance targets? And when does it happen?
- What’s the status of the RSUs if there’s a merger or acquisition?
Your employees will work longer, harder, and with higher levels of performance when they have a big financial stake in the outcomes. Inspiration rises when an employee knows there’s significant wealth in the scenario. RSUs are a way to make that happen.
Please feel free to contact me if you have questions about setting up employment agreements and compensation plans. I look forward to serving you.