What is a Restricted Stock Unit?

A Restricted Stock Unit (RSU) refers to a grant of a value equal to an amount of a company’s common stock. The RSU is typically granted to a new or valuable employee as an incentive for employment or to meet specified performance goals. In the case of a new employee, the RSU plan is commonly included as part of the employee’s initial compensation package. RSUs are very popular today with startups and technology companies seeking to hire and retain highly skilled and talented employees.

How Restricted Stock Units Work

With an RSU plan, the company offers the employee an economic interest in the company stated as a specific number of shares of company stock. The stock is not immediately given out to the employee, however, but is instead awarded at a future time upon completion of a stated goal or on reaching a stated date. In other words, the RSU plan grants a “vested interest” in the stock to the employee that is awarded at a specified time in the future, according to the plan’s vesting schedule. RSUs are assigned a fair market value and converted to stock or to cash at the time they are vested, commonly at the end of a five year period. RSUs do not pay dividends until such time as they are converted to stock.

Graduated Vesting

Graduated vesting refers to vesting schedules under which stock to be awarded as part of an RSU plan vests in stated amounts at stated intervals throughout the vesting period. As an illustration, if an RSU plan calls for the employee to become 100% vested after five years of employment, he or she may become partially vested at stated intervals during the five year period, as laid out in the RSU plan. For example, the RSU plan may call for graduated vesting as follows: 10% after one year; 30% after two years; 50% after three years; 80% after four years; 100% after five years.

Advantages to a Company Using Restricted Stock Units

RSUs are a great tool for companies seeking to hire highly talented and in-demand employees by offering them the additional incentive of taking part in the company’s growth. Additionally, RSUs are converted to stock at a future date according to a vesting schedule, and therefore provide the company with a level of security in terms of retaining top employees because those employees are likely to remain with the company until the stock benefit is fully vested.

Comparing RSUs to Stock Options

Stock options give an employee (or any other option holder) the right to purchase shares of a company’s stock at a stated specific price on or before a specific date, thus allowing the option holder the opportunity to purchase the stock at price below its current value (that is, if the stated option price is lower than the current price.) If not, the option will likely expire without being exercised, since the stock option has no value, in practical terms.

In contrast, RSUs are assigned a fair market value at the time they become vested. A closer look at the differences and similarities of RSUs and stock options are provided in this chart:

Restricted Stock Unit (RSU)

Stock Option

Value Over Time

The stock is assigned a fair market value at the time of vesting.

When the price of stock rises above the grant price, the value of the option increases correspondingly. However, if the stock price drops below the grant price, the value of the option decreases.

Vesting

In most cases the vesting schedule is completed at five years.

Stock options do not vest, but instead have an expiration date, after which the option cannot be exercised.

Term

RSUs are converted to shares once they are vested, and therefore do not expire.

Options have a stated expiration date (often, but not always, 10 years from the date they are granted.)

Taxation

RSUs are taxed as ordinary income at the time they become vested and liquid.

A stock option is taxed at the time it is exercised. Once the underlying stock is sold, the gains on the sale are also taxable at the time of the sale.

Advantages and Disadvantages of RSUs

There are advantages and disadvantages to RSUs for both employers and potential employees. Here’s a look:

Advantages for Employers Using RSUs:

RSUs are a good solution for some companies, particularly those that expect to reach their current valuation at some point in the future, such as Dropbox, Twitter, AirBnB and Square. RSUs are less likely to be used by companies considered early stage. Other benefits include:

  • Ability to attract employees because you can offer additional incentives.

  • Saves money. You are offering compensation without paying upfront.

Disadvantages for Employers Using RSUs:

As is the case with any other employee incentive offered, there are some disadvantages to a company’s issuance of RSUs. They include:

  • Your stock may not increase in value sufficiently to reward employees.

  • RSUs are not always a sufficient incentive to attract the right talent.

  • RSUs are priced at the time their stock becomes vested, and therefore, their ultimate value is unknown at the time the RSU plan is created.

Advantages for Employees Accepting RSUs:

  • Your employer is offering you an economic interest in the company in the form of stock shares.

  • Once vested, you own the stock shares at their current market value.

  • Depending on the value of the stock at the time of vesting, your earnings could be higher than originally expected.

Disadvantages for Employees Accepting RSUs:

  • The value of the stock may not be as great as anticipated.

  • RSUs typically do not fully vest for five years, meaning that if you leave the company before that time, you will lose your ability to claim some or all of the stock shares under your RSU plan.

Who Can Offer RSUs as Compensation?

Both public and private companies have the right to offer RSUs as part of their employee compensation packages.

Understanding the Value of RSUs

There are two basic methods for valuing RSUs: current valuation and future valuation. Current valuations are fact based, that is, based on the known current value of the stock. Future valuations, however, are based solely on projections, that is, simply an educated guess. Here's how they work:

  • Current Valuation Method: Current valuation works best for companies who have recently accepted venture capital funding since the value can be based on the price per share paid by the lender. For example, if you accepted the venture capital company's valuation at a per share value of $50, then the current value of a single RSU would also be $50.

  • Future Valuation Method: The future valuation method requires looking forward to what you estimate the company will be worth on a stated future date. To successfully estimate the value of the stock, you must project earnings and expenses, as well as predict potential new investments in the company. It is important to make clear to prospective employees that the valuation of the RSUs is is based solely on your estimate.

Frequently Asked Questions

  • What is a restricted security?

A restricted security (aka “restricted stock” or “letter stock”) should not be confused with an RSU. Restricted securities are common stock that become vested over time, regardless of whether they are part of an RSU or not. Restricted stock cannot be sold by the grantee until the shares are vested. In nearly all cases, the company has the right to repurchase all unvested shares if the employee leaves the company prior to becoming vested. A person with a vested interest in restricted stock is considered a company shareholder. RSU’s, on the other hand, are a popular form of employee compensation that combines the concept of a stock option with the use of restricted securities.

  • What is a phantom stock?

Phantom stock refers to a contractual agreement of a cash payment (typically offered to an employee, director, third-party vendor or other interested individual) to be paid out in the future at the occurrence of a stated specific event. Phantom stock is often used as a way to compensate certain individuals with a form of equity participation in a startup in lieu of stock options. For example, the “owner” of phantom shares may receive a predetermined amount of money when the company issuing the phantom shares goes public. Phantom shares are considered a form of deferred compensation and, therefore, are carried by the company as a liability.

  • What is a stock grant?

Stock grants refer to the issuance of an award, such as a stock option, that is provided to key employees as part of a stock plan. Stock grants allow the employee to purchase a specific number of shares of company stock at a specific price (known as the grant price) as stated in the grant. Restricted stock awarded to employees is a form of stock grant.

  • Are there better options for employee compensation than RSUs?

An RSU is only one of many types of compensation that a company might use as an employee incentive. Some companies may elect to use RSUs, while others may choose stock grants or another form of equity compensation. It is up to you to decide which form is best for your company and your employees.

  • What is RSU income?

Stock awarded as part of an RSU plan is taxed as ordinary income at the time the award, as determined by the vesting schedule. For tax purposes, the stock is assigned a fair market value at the time they become vested. A portion of the stock is typically withheld to pay taxes, with the remaining shares awarded to the recipient, who may then sell them or hold on to them, according to his or her preference.

  • How does the company’s stock value impact RSUs?

RSUs are assigned a fair market value at the time they become vested. In other words, if the company’s stock is valued at $20 per share at the time the RSU becomes vested, then the per-unit value of the RSUs is $20. As an example, if an employee is awarded 1000 RSUs at the time of her employment, and those RSUs become vested after five years, the value of those RSUs at the time they are vested is as follows:

  • Stock Value = $20 per share
  • RSU Value (when vested) = $20 per share
  • Taxable income (when vested): $20 x 1000 = $20,000

Helpful Information About Stock-Based Compensation:

Equity (Stock) - Based Compensation Audit Techniques Guide (IRS)

"Restricted" Securities: Removing the Restrictive Legend (SEC)

Sample Restricted Stock Units Agreement (Bristol-Meyers Squibb)

Restricted Stock Units (RSUs) and Backup Withholding

Example of restricted stock unit certificate