Compensatory trends continue to favour bonuses or bonus-like tools as means to reward performance, particularly due to their ability to avoid adding to fixed costs with large salary increases.
Company stock, in particular, is a popular choice for performance-based compensation, among both employers and employees alike. Contributing factors to its success include capital crunches, but also increasingly positive perceptions of the value in owning company shares.
Employees could benefit from this sort of compensation in various ways, for instance, ESOPs (Employee Stock Ownership Plans), ESPPs (Employee Stock Purchase Plans), and RSUs (Restricted Stock Units). In this article, we’ll be taking a closer look at Restricted Stock Units in particular, and what it entails from an employee’s perspective.
What Is a Restricted Stock Unit?
As highlighted above, restricted stock units are a type of compensation offered to employees in the form of company shares . Essentially, RSUs are promises of company stock, promises which are only fulfilled upon the completion of certain terms. These terms include performance milestones and employment duration.
RSUs are issued to employees through a vesting period, with a fixed distribution schedule dependent on the terms outlined above. They provide an interest in the company by gradually transferring shares to an employee. However, they hold no real value until and unless the vesting period has been successfully completed.
Once the vesting period is completed, the shares are no longer restricted, and employees have access to their monetary value (essentially owned by the employee). Taxation depends on what they choose to do with those shares.
Recommended reading: 4 Reasons Why Your Startup Needs an Employee Equity Management Software
What Do Restricted Stock Unit Timelines Look Like for Employees?
RSU timelines are generally quite straightforward. They depend on vesting schedules (time-based, usually with a duration of 4 years).
Vesting schedules can take on three forms:
1. Equal vesting schedule
The number of shares granted are vested equally over a period of 4 years. For instance, if 1000 shares are granted to an employee with an equal vesting schedule, the employee would receive 250 shares per year.
2. Graded vesting schedule
RSUs vest periodically over the vesting period, for example, 40% of the shares are vested in the first year, with 20% in each of the subsequent years.
3. Cliff vesting schedule
The entirety of the shares vest all at once. This point in time could be after a predetermined period of service, or upon the accomplishment of a set milestone.
Furthermore, the sequence of events looks something like this:
- Restricted stocks are promised to an employee on what is known as a ‘grant date’. This is not a taxable event.
- Restricted stocks then vest on the ‘vesting date’, a date upon which employees officially gain ownership of the shares. A fair market value (FMV) is assigned to these shares upon vesting. Employees are taxed on the value of the units that day.
- Some, or all, of the tax due is withheld for employees. The shares are taxed as income on the vesting date, and taxed as capital gains if the shares are held after the vesting date and sold at a later time.
What Are the Advantages of Restricted Stock Units?
Restricted stock units pose many advantages, especially since they are negotiable, low-risk investment opportunities which allow employees to benefit from future company profits. Other pros include:
1. Ease of comprehension
RSUs are often preferred by employees due to its simple nature. When compared to other equity compensation plans, restricted stock unit structures can be understood intuitively. Tracking the number of shares vested and their monetary values is clear-cut.
Restricted stock units offer employees the freedom of choice which other compensatory efforts may not. Vested RSUs do not have to be forfeited, even if employees switch jobs, thereby ensuring the stability of their investment portfolios.
Additionally, employees can even choose to cash in vested RSUs, in order to fund other personal ventures, such as retirement plans, education, home loans, etc.
3. Zero Investment
Restricted stock units essentially have no value until the vesting date is reached, and shares are earned through work performance. Given these two factors, RSUs are an attractive element of compensation packages, since employees do not need to shell out any money upfront to buy company shares.
This poses no risk to their financial portfolios, and is advantageous in the long run. Additionally, RSUs will always retain value, unless and until the share price reaches a value of zero. This is highly unlikely, so employees can rest assured they will certainly be in possession of a sound financial asset.
What Are the Disadvantages of Restricted Stock Units?
While restricted stock units may seem like the poster child for equity compensation, it is not without its downsides. Disadvantages for employees include:
1. Lack of dividends
As mentioned earlier, restricted stocks have no real value until vested, hence, no dividends are paid on the shares even though they may be allocated to employees.
However, some companies do provide the option of paying dividend equivalents into an escrow account, which can later be used to offset tax liabilities. This is a term that employees must negotiate with their employers.
2. No voting rights
Unfortunately, restricted stock units do not come with voting rights. This means that, until the shares are vested, employees have no say in any large corporate policy changes that are set to take place.
3. Potential forfeiture of stocks
Given that employees do not officially own the shares until they are vested, they run the risk of forfeiting any remaining shares if they chose to terminate their employment before the vesting date.
For instance, take an employee was guaranteed 5000 shares over 5 years, with an equal vesting schedule. If the employee remained with the company for 3 years, but left before the 5-year mark, they would forfeit the remaining 2000 shares they would have been set to gain had they stayed.
As an employee with RSUs as a part of their compensation package, what will ultimately matter are their career and financial goals. Employees can obviously maximize their benefit if they stay till the end of the vesting period, and tax liabilities can be managed with a financial advisor.
Consequently, from a company point-of-view, employee equity is not to be taken lightly. In order to provide a context in which employees feel motivated enough to maximize their benefits, companies have to equally put in the legwork. trica equity can help corporates looking to better attract, incentivize, and retain talent with state-of-the-art management software.
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