Are you interested in using employee equity compensation for your company? You might want to consider either stock options or restricted stock units (RSUs).
Restricted stock units and stock options are two of the more popular types of employee equity compensation. Choosing between stock options vs. RSU will depend on a few factors, such as each type’s benefits and disadvantages, the stage of the company’s growth, and the preferences of the employees and shareholders.
Let us walk you through all the things you need to know.
Stock options is a type of equity compensation that allows employees to purchase company stock at a predetermined price, which is called the strike price or exercise price. The strike price or exercise price is usually set at the fair market value of the company’s stock at the time the option is made available.
Stock options usually have a minimum time requirement called a vesting period that employees must reach before being eligible to buy. The typical vesting period is 3-5 years.
Stock options have several types, but two of the most common ones are incentive stock options (ISOs) and non-qualified stock options (NSOs). This type of equity compensation is commonly used by early stage startups and publicly held companies.
Although this type of equity compensation plan grants employees the right to purchase stock, they can’t do so right away. Employees need to reach the required vesting period before becoming eligible to exercise options.
For instance, if the employee compensation plan grants an employee options with a five-year vesting period, an employee must stay within the company for the entire predetermined vesting period of five years before they can exercise their options to buy company shares. Once the employee has done this, they can gain full ownership of the shares of company stock units.
However, if the company is private, the purchased stock will likely be restricted. This means the employee will not be allowed to sell the shares without the company’s approval. But if the company is public, the stock will generally not be restricted after the company reaches an IPO.
Incentive stock options, as the name suggests, are given to employees as an incentive to help the company succeed. Companies usually offer shares at a discounted price, so employees have a chance to own company stock if they exercise the granted options.
Once they have purchased stock units, they will be motivated to work hard. After all, they will share in the success of the business.
Aside from a discounted price, ISOs also benefit from tax advantages, provided that certain criteria are met. If the employee holds the stock for a minimum of two years from the date of the grant and at least a year from the date of exercise, any gains from the sale of the stock are taxed as long-term capital gains and not as ordinary income. This can mean significant tax savings for both the employee and the company.
On the other hand, NSOs are simpler and have more relaxed requirements than ISOs. In fact, they are called “non-qualified” because they lack some criteria for them to qualify as ISOs.
NSOs don’t have the same tax benefits as ISOs. Any profit from the sale of purchased stock will be taxed as income, even if the employee held the stock for years before selling.
Here are some of the benefits of stock options:
On the other hand, here are some of the disadvantages of stock options:
If stock options give employees the right to purchase company shares after a pre-set time, restricted stock units grant employees (or contractors, advisers and other stakeholders) the right to receive company shares when certain restrictions or vesting requirements are met.
RSUs, like the name suggests, are restricted units, meaning the employee cannot dispose, sell, or transfer the shares until certain conditions are met. However, once vested and fully delivered, employees can opt to sell shares. Any profit from the sale will be subject to capital gains tax.
RSUs have two types: single trigger RSUs, and double-trigger RSUs. Private companies in particular prefer double-trigger RSUs over single-trigger as they have much better tax implications for the employees.
If stock options have a fixed, time-based vesting schedule, RSUs have one or two milestone-based vesting triggers. Once this trigger or triggers are met, the RSU is considered vested and will be delivered to the employee.
Single trigger RSUs vest on a single trigger milestone or event, such as a company merger or acquisition. Double-trigger RSUs vest on two events, such as an acquisition or an IPO and hitting a revenue goal within a certain timeframe.
RSU triggers vary depending on the terms of the company. Some companies may use time-based single triggers similar to a stock option’s vesting schedule.
Here are some of the benefits of RSUs:
Take note: dilution of shares from granting restricted stock options to employees can be avoided with issuance of non-voting interests.
The common drawbacks of RSUs are as follows:
Stock options and RSUs are both employee compensation benefits that give the recipient the right to buy or receive company shares at a future time. However, there are key differences you need to consider, such as:
Restricted stock units are more flexible. They can be awarded on a performance benchmark, predetermined vesting schedule, or both.
Choosing between stock options vs. RSU depends on your unique circumstances and priorities. Some experts say that stock options are best for publicly held companies. However, there’s also the risk that the stock price will drop below the set price, meaning you could lose money.
Restricted stock units, particularly double-trigger RSUs, offer a more predictable return. There’s no worry about the value of the stock going “underwater.” As long as the stock’s value is more than zero, a positive return can be obtained. Experts believe that double-trigger RSUs are the best employee equity compensation among private companies.
The decision between stock options or RSUs comes down to your financial goals and risk tolerance.
At Upstock, we help forward-thinking companies deploy state-of-the-art equity plans. We also help communicate to your employees the details of the equity plan and their particular offer. This includes when they're likely to receive a payout of the award, and what the company needs to get there.
Upstock does this through intuitive and inspiring dashboards, educational materials, and informational explainers. Our plans are available in over 70 countries.
With Upstock, you can ensure your employees are aligned with your interests regardless of where they're located around the world. We can provide you with general information on RSUs and what experts are saying about it as well.
If you’re still unsure of what’s best for you, we have some thoughts on this topic that could help you decide. Let’s discuss and get on a call by clicking here.
Disclaimer: This material has been prepared for informational or education purposes only. The discussions or information contained herein is based on sources reasonably believed to be reliable but which has not been independently verified by Upstock or an independent tax or legal professional. Thus, it is not intended to provide, and should not be relied upon for tax, investment, business and/or legal advice. Please consult with your own tax or investment adviser and legal counsel regarding this subject matter especially with respect to the relevance or accuracy of any discussion or information contained in this material under the applicable laws, rules and regulations in your jurisdiction.