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Companies use a variety of compensation plans to attract and retain top talent. One potential component of these plans is a form of equity compensation, which is used to align employees with the goals of the company so that they can share in its success. While there are a number of equity packages companies can offer, restricted stock units, or RSUs, are quickly becoming the option of choice to replace stock options as the equity portion of a compensation package.
What are RSUs?
Much as the name suggests, restricted stock units are a form of stock compensation that has restrictions placed upon it. In most cases, that restriction is a vesting schedule whereby the employee will receive distributions of the company's stock upon meeting certain goals, or time horizons. A common vesting plan is for an employee to receive a portion of the RSUs each year on the anniversary of the person's start date with the company.
One other thing worth noting about RSUs is that they're quite different from stock options when it comes to taxes. The shares received from the RSU are considered to be income to the employee as soon as the shares vest. A portion of the shares are therefore often withheld to pay taxes. Furthermore, the employee pays taxes not only on the value of the shares when they were offered at their current income tax rate, but also on the capital gains, if there are any, at their capital gains tax rate.
An example of RSUs in action
Congratulations: You've just been hired as the CEO of ReallyCoolCo! In addition to your lavish compensation and benefits package, you've been given 1,000 RSUs that have a market value of $50 per share. There is, however, a catch. Half of the RSUs vest over a five-year period, and the other half are awarded if you meet the goal of doubling the company's revenue each year.
Being the exceptional manager you are, you not only survived your first year in the C-Suite, but you also managed to double the company's revenue. As a result, 200 shares vested and are now yours. That not only makes you happy, but it also puts a smile on Uncle Sam's face since you now owe taxes on the $10,000 in income received from the shares (200 shares x $50 per share). Furthermore, because the stock price doubled over the past year, you'll also owe capital gains taxes on the $10,000 gain ($100 - $50 = $50 x 200 shares) even if you didn't want to sell your shares. Instead, your company would have to sell enough of the shares to withhold the money to cover both your income tax and capital gains taxes.
Ideally, that situation would continue for all five years. However, if you burned out before the end of year two and left the company, you'd have to forfeit the rest of your RSUs. Likewise, the revenue-based performance RSUs would vest only if you met your goal each year. Otherwise, that year's batch would be forfeited. In other words, if the goals are met, the RSUs vest, and if not, they're forfeited for that year.
Takeaway
RSUs are an equity compensation tool that a company can offer to hire and retain key employees. These help to keep employees motivated to stay with a company over the long term, since they'll benefit from the value the RSUs are creating.
