Imagine after multiple rounds of grueling interviews, numerous discussions with hiring managers and HR managers, and after putting in a lot of efforts from your end, you get your dream job in your dream company. You are only ‘this’ far from getting an offer letter. The only thing that is pending is salary negotiation.
You are smart and you nailed the salary negotiation also. Company offered you a good salary hike, and a joining bonus too. But wait, is that all? Can you add some extra perks to your compensation? Why not? That’s where Restricted Stock Units, or in short RSUs, come into picture.
What are Restricted Stock Units?
A publicly listed company can offer its shares to its employees as a part of their compensation package. These offered shares are known as Restricted Stock Units. But why are they “Restricted”? That’s because employees cannot sell these shares immediately. How soon they can sell these shares depends on the company’s policy for offering RSUs. Let’s see how,
There are two important dates to consider when talking about RSUs. The date at which the RSUs are offered to an employee is called a “Grant Date”, and the date at which the employee receives actual shares in their account and becomes eligible to sell those shares is called a “Vesting Date”. RSUs are considered as a part of employee’s gross income beyond vesting date.
For example, if you join a company and it offers you RSUs on 1st July 2020, then this date is the grant date. However, as per company’s policy, if you cannot sell and encash those shares unless you stay with the company for at least a year, then 1st July 2021 will be the vesting date. After 1st July 2021, you will receive shares in your account which you can hold further or sell in the open market.
Now, that’s the simplest explanation to understand grant date and vesting date. If you have understood that, let’s move further to understand the “Vesting Plan and Distribution Schedule”.
A company may decide to allocate RSUs to employees based on a multi-year schedule. For example, your company’s vesting plan may offer you RSUs over 5 years. So, at the end of your first year with the company, you will get 20% of allotted shares at a fair market value (current price of the shares in the stock market). In other words, allotted RSUs can be vested over the period of 5 years and you will get all the shares at the end of 5 years if you decide to stay with the company for that long.
One more thing to consider here is that the company may also add a performance criteria to the vesting plan, and if you meet the required performance benchmark then only you will be eligible to receive corresponding shares after the end of each year. For example, if you do not meet the performance benchmark at the end of your second year, company can forfeit your shares that you were supposed to get at the end of the second year. Vesting plans may vary from company to company.
Benefits of RSUs
RSU is a win-win for both, employees as well as employers. It’s a motivation for employees to stay longer with the company and perform better, so that if the stock price increases with the growth of the company, stocks will be worth more than the initial value at grant date.
For example, if the company gives you 1000 RSUs at the time of joining and shares are worth ₹500 each at that time, it means that you are entitled to receive 1000 x 500 = ₹5,00,000 in total at the end of 5 years with the company. Each year you will receive 200 units which you can encash by selling the shares in the open market at a fair market value.
Now assume that the company’s share performance at the end of each year is as follows, and according to the varying share prices you will earn different amounts at the end of each year,
|Year||Share Price||Shares You Sell||Money You Get|
Notice that you end up earning ₹54,000 more than what you were initially entitled to receive if you stay with the company for a longer term and assuming that the share price was increased over those years. Now, that’s a free money and who doesn’t want that?
The company’s benefit is that it gets employees to stay longer. Employees also perform better since they have a motivation towards appreciating their share’s worth, and also meet the required performance benchmark at the same time. The other benefit is that the company doesn’t have to issue all the shares at once and can delay the distribution as explained above.
Also, if an employee leaves the company earlier, the company can forfeit the remaining RSUs. So, if the vesting period is 5 years, and you leave in just 2 years, you will be able to encash only 40% of the RSUs and the company will keep the remaining 60%.
Downside of RSUs
There are two major drawbacks of RSUs.
No voting rights – As you must have understood by now that you don’t own any real shares until vesting date, you don’t get any voting right as a shareholder. You get that only after the vesting date as that’s when you have actual shares with you. It seems OK to me, because even if you don’t have voting rights, you can influence company growth as an insider.
No dividends – Again, since you don’t own any shares until vesting date, you don’t get any dividends till that time. I look at it like this – anyways these are free shares for you since you haven’t paid anything to get these shares (other than your hard-earned skills, sweat and time during interview to get the job). So, you are going to benefit from capital gains when you sell the shares after vesting date.
You will get dividends only if you decide to keep the shares instead of selling those immediately after vesting date.
How are RSUs different from Stock Options?
Stock Option was a famous and well-known method to compensate employees with company’s equity. However, with the introduction of RSUs, popularity of Stock Options greatly reduced. With Stock Options, there is a chance that the options would expire worthless due to the way Options work. If you want to learn more about how to trade Options, please contact us at email@example.com for our course on Options Trading.
In case of RSUs, the value of the compensation will never be zero as the underlying share will have some value on the vesting date, unless the company files bankruptcy of course.
Do you have to pay taxes?
Absolutely yes. As I mentioned earlier, RSUs on vesting date are considered as a part of the gross income of an employee, you need to pay income tax. You also need to pay capital gains tax if you profit from selling the shares in the open market. You have various options for paying taxes.
Withhold to cover – The company will withheld the number of shares that are required to pay applicable taxes on your income. For example, if 80 shares are required out of 200 allotted shares to pay the necessary taxes, then the company will withheld those 80 shares and release the remaining 120 shares to you.
Cash – In this case, you will receive the full amount of eligible number of shares. However, you will be responsible for paying the taxes either through your payroll or directly paying the required amount to the company.
Sell to cover – In this option also you will receive the full amount of eligible number of shares. You can contact third party financial institutes to sell the required number of shares to cover your taxes. Remember, these institutes may charge you transaction charges and applicable fees.
So, next time when you switch your job, don’t forget to ask hiring manager about allotting RSUs as a part of your overall compensation. It will definitely benefit you in the long run.
Please add your comments below and let me know what you think about RSUs?