editione2.1.1Updated September 12, 2022
While stock options are the most common form of equity compensation in smaller private companies, RSUs have become the most common type of equity award for public and large private companies. Facebook pioneered the use of RSUs as a private company to allow it to avoid having to register as a public company earlier.
Definition Restricted stock units (RSUs) refer to an agreement by a company to issue an employee shares of stock or the cash value of shares of stock on a future date. Each unit represents one share of stock or the cash value of one share of stock that the employee will receive in the future. (They’re called units since they are neither stock nor stock options, but another thing altogether that is contractually linked to the value of stock.)
Definition The date on which an employee receives the shares or cash payment for RSUs is known as the settlement date.
caution RSUs may vest according to a vesting schedule. The settlement date may be the time-based vesting date or a later date based on, for instance, the date of a company’s IPO.
RSUs are difficult in a startup or early stage company because when the RSUs vest, the value of the shares might be significant, and taxes will be owed on the receipt of the shares.* This is not a bad result when the company has sufficient capital to help the employee make the tax payments, or the company is a public company that has put in place a program for selling shares to pay the taxes. But for cash-strapped private startups, neither of these are possibilities. This is the reason most startups use stock options rather than RSUs or stock awards.
RSUs are often considered less preferable to grantees since they remove control over when you owe tax. Options, if granted with an exercise price equal to the fair market value of the stock, are not taxed until exercise, an event under the control of the optionee. If an employee is awarded an RSU or restricted stock award which vests over time, they will be taxed on the vesting schedule; they have been put on “autopilot” with respect to the timing of the tax event. If the shares are worth a lot on the date of vesting, the tax burden can be significant.
confusion You don’t want to confuse restricted stock units with restricted stock, which typically refers to restricted stock awards.
Usually you need the cash to buy shares—maybe more than you can afford to pay at exercise time. Another, less common approach to be aware of is for companies to allow the person exercising options to avoid paying the cash up front and instead accept a promise of payment in the future.
Definition A company may accept a promissory note to exercise compensatory options. Essentially, a promissory note is like giving an “IOU” to the company instead of paying the company cash for shares. The note may either be a recourse promissory note or non-recourse promissory note. “Non-recourse” means the lender (the company) is prohibited from seeking a deficiency payment from the borrower (the recipient of the stock) personally if they do not pay; they only can foreclose on the property itself (in this case the stock).
technical The tax consequences to the company and the optionee depend on how the note is structured. If the note is non-recourse, for state law purposes the company will consider you an owner of the shares received in exchange for the non-recourse note, but the IRS will consider the shares still an option until the promissory note is paid (which would also affect timing for long-term capital gains).