ESOP

What are Restricted Stock Awards (RSA)?

Unlisted
August 29, 2022

What are Restricted Stock Awards (RSA)?

Restricted Stock Awards (RSA) is a popular way to incentivise early employees in companies. It means grant of company stock, which are restricted as the employee still have to earn the right to keep the shares after they are issued. This incentivise the employee to stay with the company longer

RSA are often used by young companies and is an important part of the compensation structure, so that cash compensation can be kept to a minimum in the early days when cash is scarce. The employee is hence compensated and motivated by a potential significant gain on share price over time.

So, in other words, RSA can be compared with an investment in the company, where the receiver is an employee which was given the opportunity to buy shares at a favourable price. However, the employees have to return the unvested shares if they leave early without providing the anticipated value . This serves to protect the company and prevent ending up with what is often called “dead equity” and a “broken cap table” which can cause frustration and make it hard to raise outside capital.

How does RSA Work? 🤝

Once an employee is granted (offered) a Restricted Stock Award, the employee must decide whether to accept or decline the grant

The grant may be given free of charge, but are in most cases purchased. Since this instrument is most often used in the early days of a company, the price can be very favourable. Even after taking outside investments if this is done with a convertible note. More on this in another blog post

After accepting a grant and providing payment (if applicable) the employee must wait until the grant vests before the restrictions are lifted. The restriction period is often called vesting period.

There are two main types of vesting; time-based vesting or performance / conditional based vesting. The most common type of vesting in early stage companies are time-based vesting. If the employee were to leave the company before the vesting period expires, the company has the right to buy back the unvested shares for the same price the employee purchased the shares for. It is also normal that the shares vest gradually during the vesting period.

Let´s illustrate this with an example: If an employee is granted RSA with a vesting period of 4 years with gradual vesting every quarter, the employee have to work 4 years to earn the right to keep all the shares. If the employee were to leave the company after one year, he/she has earned the right to keep the vested shares (1/4 of the granted shares).

Illustration vesting time

Tax considerations 🧾

  • If RSA are given at no cost, this is considered a benefit which is in most jurisdictions taxed as normal income tax (Norway)
  • If the RSA is purchased below the fair market price. The difference from the fair market price and purchase price is considered a benefit which is in most jurisdictions taxed as normal income tax (Norway)
  • If the RSA are purchased at fair market price, no immediate tax is applicable
  • Any potential gains on the shares are taxed as capital gain tax (usually favourable low compared regular income tax)
  • For company only: If the RSA is given at no price of with a discount, the company is required to pay employer´s tax where applicable (Arbeidsgiveravgift in Norway)
  • (For US only: Special tax 83(B) Election is an alternative)

Advantages with RSA 👍

  • Shareholder: You receive and legally own the shares at the day of grant (day 1)
  • Voting rights: When you are a shareholder, you generally have voting rights
  • Dividends: When you are a shareholder, you generally have right for dividend
  • Reduced Tax: Typically reduced tax as in most cases capital gain tax apply over income tax.
  • Favourable Price: You may be able to purchase the stock at a favourable price at the start of the company

Disadvantages with RSA 👎

  • Instant Payment: If the RSA has a purchase price, this have to be paid at the date of grant
  • If the RSA is given at no price of with a discount, this triggers an instant taxation requirement for the receiver. And since the stock is restriction this cannot be sold to cover tax cost.
  • If the RSA is given at no price of with a discount, the company is required to pay employer´s tax where applicable (Arbeidsgiveravgift in Norway)
  • Risk: Since the receiver have to pay upfront, there is a risk for loss of capital if the company fail

Two types of Restricted Stock

Restricted Stock Awards (RSA) should not be confused with Restricted Stock Units (RSU). The difference is that RSU is a promise to receive stock in the future (after vesting) at no cost. Special tax considerations apply in that case, which we will cover more in future blog posts.

Was this helpful and do you want more?

We hope you found this helpful🦸 We would love to get your feedback on this. Please send any feedback or questions to us at hello@unlisted.ai

And if you do want to learn how we can help you implement and administrate Employee Stock Ownership Plans (ESOP) in your teams, feel free to book a free call with us

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