From Stock Options to RSUs: Shifting Tides in Employee Compensation

Casey Fenton

|

December 7, 2023

Ever wondered why more and more companies are gravitating towards RSUs instead of traditional stock options or other equity awards?

It's not just a fleeting trend. In today's competitive hiring landscape, equity awards aren't just the icing on the cake; they're a critical part of the recipe. 

Now, while there's a buffet of equity choices available to companies, RSUs are emerging as the main course many are opting for. They're stable, they're straightforward, and they come with a unique set of perks that both employers and employees find enticing.

So, why the shift towards RSUs, and how do they compare to other equity rewards?

RSUs – The Modern Equity Award

Today's businesses are realizing the power of RSUs. But before diving deep into their charm, it's crucial to get the basics right.

Definition and Basics

Imagine a scenario: a company tells an employee that if they stick around for, say, three more years, they'll be rewarded with actual company stocks. That’s the essence of Restricted Stock Units (RSUs).

RSUs are commitments that, after a specific period called the vesting period, an employee will receive a set number of the company’s shares.

The best part? There are no immediate costs or taxes when these RSUs are awarded. It's like getting a golden ticket, only to cash it in later!

Distinct Advantages of RSUs

It's not just about giving out shares. RSUs come with some compelling advantages that make them stand out.

  1. Guaranteed value: Ever observed the stock market’s roller-coaster ride? RSUs offer a buffer against it. No matter the market's ups and downs, once RSUs vest, they’re converted into actual shares with tangible value.

  1. Fosters employee retention: Who wouldn't want to wait a while if they knew they'd get company shares at the end of it? RSUs serve as a magnetic pull, encouraging employees to stay with the company until their RSUs vest and become real shares.

  1. Simplified structure: Think of the most hassle-free equity arrangement possible. That’s RSUs for you. There’s no complex calculations or watching the stock market with bated breath. Employees know exactly what they’ll get once the vesting period is over.

Handling Challenges with RSUs

Of course, like everything valuable, RSUs come with their set of challenges.

Let’s first address the tax implications. It's true that when RSUs vest, they’re subject to tax.

However, most companies provide detailed guidance to employees, helping them navigate these waters. And with some foresight, these taxes can be managed effectively.

On the other hand, this also poses a potential upside: RSUs might not make employees overnight millionaires like some stock options have the potential to. But their consistent and predictable nature gives them an edge, making them an attractive option for many.

After understanding RSUs in their entirety, one might wonder how they compare to stock options, which once held the crown in the equity awards arena. Time to explore that!

Stock Options – A Double-Edged Sword

While RSUs are making waves in the modern equity landscape, stock options have long held the spotlight. So what makes stock options tick, and why are they often likened to a double-edged sword?

Definition and Basics

Picture this: A company offers an employee the chance to buy its stock, not immediately, but at a later date and at a price set today.

That’s the magic of stock options. They grant employees the right, but not the obligation, to buy company shares at a set "exercise price." For instance, if a company’s stock is currently valued at $50, it might offer stock options with an exercise price of $55, betting on future growth.

Potential Upsides of Stock Options

There's a thrill associated with stock options. When the stars align, the results can be spectacular.

For instance, the potential for higher profits. Imagine the company's stock price skyrocketing to $75 in a year. Employees holding options with an exercise price of $55 can buy shares at that price and instantly benefit from a $20 per share gain.

There’s also the flexibility in exercise. With stock options, timing is of the essence.

Employees get to decide when to cash in, giving them the freedom to optimize their gains. If they believe the company's stock will rise further, they might hold off on exercising their options.

Common Concerns with Stock Options

However, the ride isn’t always smooth. Stock options come with their share of bumps.

Stock options have the risk of being underwater. Back to the earlier example – if, instead of rising, the company’s stock drops to $40, those options with an exercise price of $55 suddenly don’t look so appealing.

They're "underwater," meaning the exercise price is higher than the current market value. No one wants to buy stock at $55 when it’s available in the open market for $40.

Compared to RSUs, stock options aren't exactly beginner-friendly. They come with expiration dates, which means if employees don't exercise them within a set period, they vanish.

Then there's the juggling act with the exercise price, market predictions, and tax implications. It’s not all rainbows and roses.

While stock options have their moments of glory, they also come with potential pitfalls. Having looked at both RSUs and stock options, the natural question arises: How do these two compare directly, and where might other equity awards fit into the picture?

Exploring Other Equity Awards

While RSUs and stock options tend to steal the limelight, the world of equity awards is vast and varied. Some lesser-known instruments bring their own unique advantages and quirks to the table.

Employee Stock Purchase Plans (ESPPs)

Think of a scenario where employees get a golden opportunity to buy company stock at a price lower than what the rest of the world pays. That's the beauty of Employee Stock Purchase Plans (ESPPs).

For instance, if a company’s stock trades at $100, employees might have the chance to snap it up for $85 through an ESPP. It's like an exclusive sale event, just for employees.

However, this isn't a free-for-all. ESPPs come with set purchase periods. And while the discount is tempting, there's still a financial commitment involved, and the stock market's unpredictability means there's no guarantee of a profit.

Performance Shares and Units

Picture an employee who’s been crushing targets and consistently outperforming peers. Companies might reward such high-flyers with performance shares or units. It's like saying, "You’ve been awesome, and if you keep it up and we hit our company-wide goals, you'll get this special stock reward."

For example, if a company sets a revenue target of $1 million for the year and it's achieved, those holding performance units could see them converted into real stock. However, if the company falls short, those units? They could vanish into thin air.

Phantom Stock and Stock Appreciation Rights

Now, here's a twist. What if employees could reap the benefits of stock price increases without ever actually owning the stock?

Enter phantom stock and stock appreciation rights. If a company's stock price goes from $50 to $70, employees with these rights would benefit from that $20 increase.

It's like shadow boxing with the stock market — getting the feel of the action without the actual contact. The downside? Without the tangible ownership of actual shares, some employees might feel these awards are a bit...ephemeral.

Now, with RSUs, stock options, ESPPs, and more in the mix, how does an employer decide what’s best for their unique environment?

Making the Right Choice as Employers

In the intricate dance of equity awards, making the right choice can feel like mastering an elaborate choreography. However, with a clear understanding of each instrument's rhythm, employers can confidently lead the way.

Tax Implications

It’s undeniable – tax implications can turn even the most exciting equity award into a complicated puzzle. Each type of award has its unique tax intricacies.

Take RSUs, for example. When they vest, they’re treated as income. That means the amount they’re worth at vesting gets taxed as regular income.

Luckily, many companies automatically withhold the necessary taxes at vesting, making the process smoother for employees. It’s like having a dance partner who expertly leads through the trickiest steps.

Prioritizing Employee Retention and Motivation

Finding ways to keep top talent onboard and motivated is a perennial challenge. In the quest to foster loyalty and drive, RSUs often emerge as a star player.

Their guaranteed value – turning into real shares after the vesting period – offers employees a compelling reason to stay. It's akin to a promised encore performance after a stellar show.

Regulatory and Compliance Insights

Just as there are rules in dance, there are legalities in equity. Missteps can lead to costly repercussions.

Delving into the world of RSUs, their structure tends to be more straightforward, often making compliance a less daunting task. There are fewer variables at play compared to, say, stock options with their exercise prices and expiration dates.

So, while it's essential to be cautious and consult legal counsel, RSUs can sometimes make the regulatory waltz a tad more graceful.

Aligning with Company Vision

A company's goals and vision are its guiding star. Whether aiming to disrupt markets, achieve rapid growth, or prioritize stability, the chosen equity award should mirror these aspirations.

RSUs, with their inherent stability and predictability, might resonate well with a company seeking steady growth and employee retention. Meanwhile, stock options, with their high-risk-high-reward nature, could be the choice for companies chasing aggressive expansion.

Ultimately, the selection of the right equity award intertwines with a company’s core values, goals, and strategy. It’s not just about the immediate appeal but ensuring the long-term harmony of the company's growth dance.

Final Thoughts

The realm of equity awards is as diverse as it is dynamic. From the high-adrenaline world of stock options to the steady allure of RSUs, choices abound.

But amidst this kaleidoscope, RSUs shimmer with a unique glow. Their simplicity cuts through the complexity, their stability offers a reassuring anchor, and their undeniable appeal to employees makes them hard to overlook.

Equity compensation isn’t just about numbers and stocks; it's about aligning with values, fostering loyalty, and charting a path for mutual growth.

For employers on the cusp of a decision, remember this: The right equity award can be transformative. It can energize a workforce, reinforce commitment, and set the stage for unprecedented success.

Want to know more about equity compensation and how you can use it to your advantage? Drop us a message.

Equity should be easy to understand

Figuring out equity offers can leave you feeling demotivated and paralyzed. Upstock makes equity motivating, inspiring, easy to deploy.

Learn More
ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

Previous: From Startup to Success: Navigating Series A Funding‍ Next: From Strip Clubs to Stock Markets: The Stripper Index and Its Relevance to Employee Stock Choices