ESOP

What are Restricted Stock Units (RSU)?

Unlisted
September 6, 2022

What are Restricted Stock Units (RSU)?

Restricted Stock Units (RSU) is simpler then Restricted Stock Awards (RSA). RSU is an equity compensation where the receiver is promised free stocks in the future after meeting certain vesting conditions. See more below

In other words, an RSU holder is not considered a shareholder until the RSU vests and are settled into shares in the company. This means that the RSU holder do not have any voting rights or rights to receive any dividends

This is an alternative way to incentivise employees in companies. Also here the vesting schedule serve to incentivise the employee to stay with the company longer. If the employee decide to leave before the vesting period ends, the employees lose the right to receive free stock in the future. 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 RSU Work?

Once a receiver is granted a Restricted Stock Unit, he/she must decide whether to accept or decline the grant. The receiver must wait until the grant vests before the RSU can be settled into shares. The 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 receiver lose the right to receive the free stock. It is also normal that the RSU´s vest gradually during the vesting period.

Let´s illustrate this with an example: If an employee is granted RSU with a vesting period of 4 years with gradual vesting every quarter, the employee have to work 4 years to earn the right to settle all the RSU´s. 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).

Tax considerations

  • Since the receiver takes no risk and receive the stock free of charge, this is typically considered a benefit and is in most jurisdictions taxed as income tax upon the time of vesting.
  • For US only: Special tax 83(B) Election is an alternative
  • 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)

Advantages with RSU

  • No cost: There are no cost for receiving RSU´s. And shares are received at no cost when they have vested.
  • No initial risk: The RSU receiver do not have to pay anything at the date of grant and hence do not bear any initial risk for loss. After vesting, the tax cost needs to be considered.
  • For companies: Less actual shareholders to report to and gather votes from etc.

Disadvantages with RSU

  • Shareholder: The RSU holders do not become a shareholder until the RSU´s vest and are settled
  • The RSU holder has no voting rights
  • The RSU holder is not entitled to dividends
  • Tax: All gains are in most jurisdictions taxed as income tax. Hence higher tax rate than capital gain tax. Tax typically become applicable when the RSU vest and settled to stock.
  • The company is required to pay employer´s tax where applicable (Arbeidsgiveravgift in Norway)
  • Cash squeeze: When RSU vest, the receiver has to pay income tax. If the shares are not liquid (easily sellable) at the time of vesting, the receiver might get a big tax claim, which they do not have the money to pay for. This is typically a challenge in private companies.

Two types of Restricted Stock

Restricted Stock Awards (RSA) should not be confused with Restricted Stock Units (RSU). The difference is that with RSA´the receiver owns the stock (with restrictions) from the date of grant, while RSU is a promise to receive stock in the future (after vesting) at no cost.

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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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