Restricted stock units (RSUs): How do they work?

When it comes to employee compensation, a regular paycheck and basic benefits are just the tip of the iceberg. Beneath the surface lies a world of perks that convince jobseekers to sign on the dotted line and keep existing talent around for the long haul. 

Restricted Stock Units, or RSUs, are a type of equity compensation that fosters a symbiotic employee-employer relationship. Organizations can choose from different RSU structures, providing stock options and other incentives to motivate employees to invest back into the company’s future. This aligns workers’ day-to-day efforts with long-term success while boosting the value of the workers’ stock portfolios.

Read on to learn more about how RSUs can set your business apart in a competitive job market and how Oyster can fill your total rewards program with innovative employee benefits that boost employee engagement and retention. 

What is a restricted stock unit?

A restricted stock unit is a type of incentive-based compensation companies use to reward employees. Simply put, RSUs are a promise to give employees shares of company stock at a future date, typically linked to specific milestones. This might include time-based RSUs, which vest over a set period, or performance-based RSUs, which vest when performance goals are achieved. 

RSUs can be a game-changer for your organization’s compensation package since they offer direct benefits to employees and employers. Aligning employee interests with the company’s growth strategy enhances job satisfaction, boosts loyalty, and provides a valuable opportunity for long-term financial health. 

How do RSUs work? 

The timeframe for meeting milestones is called a vesting period or vesting schedule. During the vesting period, the shares are restricted, meaning they have no tangible value. Employees can’t sell or transfer RSUs until they vest, ensuring that they stay committed to the company’s mission. 

Once RSUs vest, employees can cash them in or hold onto them like they would a share of any other company’s stock. The length of the vesting period can vary widely, although a typical range is between one and four years. Typical vesting schedules include time-based vesting, either delivered in a lump sum or gradually over time (e.g., 25% per year for four years), or performance-based vesting, where shares vest only when a specific performance metric is met. 

Organizations have the flexibility to design their vesting schedules to align with their business goals. With careful strategy, you can incentivize employees to stay with the company and contribute to specific growth initiatives. 

Advantages and disadvantages of offering RSUs

The options when crafting a compensation package are vast—RSUs can provide a competitive edge. But are they the right fit for your organization and employees’ needs? Let’s examine the pros and cons.

Advantages of RSUs

RSUs are one way to keep your employees’ eyes on the prize—whether that’s sticking around for several years or prepping the company for its big IPO. Need more convincing? Let’s explore four benefits of RSUs:

1. Attract top talent: If you want a competitive workforce, you need competitive benefits. Candidates are seeking more than a good salary. They want personalized monetary and nonmonetary benefits that contribute to their personal and professional growth. RSUs give new hires a stake in the company’s future, reflecting an organizational commitment to mutual success.
2. Cushion lower salary: You can’t always pay top dollar, especially in the early stages of growth. RSUs are an equity incentive that can offset a less competitive take-home pay with potential future gains, increasing the appeal of your overall compensation package. Plus, RSUs have no upfront cost—companies don’t have to pay out until shares vest and are issued. 
3. Align interests: When workers are focused on small daily tasks and short-term deadlines, they can lose sight of the long-term mission. Performance- and metric-based RSUs ensure that employees are always in tune with the bigger picture. They benefit directly from the company’s big successes. 
4. Small administrative costs: Managing RSUs is relatively straightforward compared to other equity compensation plans, such as exercising stock options or managing a virtual stock option plan (VSOP). RSUs are easier to track and manage since they automatically convert into shares of company stock. 

Disadvantages of adding RSUs to your compensation package

Complex tax burdens, market fluctuations, delayed dividends—these are a few potential obstacles related to this type of stock compensation:

1. Delayed dividends: Employees don’t receive cash dividends until their RSUs convert into company shares. Unachievable performance metrics or RSUs that take a decade to vest may not be a convincing argument to retain talent. Workers might forfeit unvested RSUs to seek better earnings elsewhere. 
2. No voting rights: RSUs don’t grant voting rights until shares are issued. That means employees don’t have a say in company matters, such as mergers, acquisitions, or other strategic initiatives that impact their equity value. This lack of input can lead to disengagement from employees who are eager to influence the company’s direction. 
3. Tax complexities: When RSUs vest, they’re considered taxable as ordinary income. Employees will pay income tax on the fair market value of their shares of stock. This means a higher tax liability, especially if the stock price rises significantly. Likewise, future gains are subject to capital gains tax, which requires careful financial planning. 

Example of RSUs

How do RSUs fit into a compensation package? Let’s look at a hypothetical example. 

Sarah, a software engineer, receives a job offer from a tech startup that includes 2,000 RSUs as part of her compensation package. The offer outlines a six-year vesting schedule, with 25% of the shares vesting each year after her second work anniversary, but only if the company meets a specific revenue target of $5 million in profits each year. 

• Years 1 and 2: Sarah stays with the company. 
• Year 3: After her second work anniversary and successfully hitting the target, 500 RSUs vest. At a stock price of $20 per share, Sarah decides to cash her company shares at a value of $10,000, which is taxed as ordinary income. 
• Year 4: Another 500 RSUs vest, contingent on meeting the same profit goal. The company exceeds expectations, increasing its stock value. Sarah gains these shares at $30 each. Sarah decides to keep her company stock invested at a value of $15,000 before taxes. 
• Year 5: Due to a dip in the market, the company fails to meet the $5 million revenue target. Sarah doesn’t receive her 500 RSUs. 
• Year 6: The market bounces back. The company meets its revenue target, and the stock’s value hits an all-time high of $45 per share. Sarah receives her 500 RSUs. Her combined 1000 RSUs have a total value of $45,000 before taxes. 

How are restricted stock units taxed in the United States?

When it vests, the RSU is assigned at a fair market value. At this point, it’s considered ordinary income, which has tax implications.

How does taxation work for RSUs in the U.S.? A portion of the shares is usually withheld to pay the relevant income taxes immediately, and the employee then receives the rest. Since those shares are vested, the employee can do what they want with them—sit on them or sell.

Offer competitive benefits and boost employee retention

Not sure where stock compensation fits into your total rewards package? We’re here to help. With experience creating employee benefits plans in 180+ countries worldwide, Oyster can guide you in designing a competitive offering that attracts and retains top talent. Let’s build a brighter future for your team together. Get started today. 

FAQ

Do you have questions? We have answers.

What’s the difference between stock options and restricted stock units?

Stock options are a popular type of equity compensation. Unlike RSUs, which are awarded to employees as future shares free of charge, stock options grant employees the right to buy a set number of shares at a predetermined strike price within a specific time frame. 

What’s the difference between restricted stock units (RSUs) and restricted stock awards (RSAs)?

RSAs provide immediate stock ownership upon grant, whereas RSUs promise future shares. With RSAs, employees enjoy voting rights and dividends right away. Tax treatment differs, too—RSAs have no immediate tax implications if the employee pays fair market value, with future gains subject to capital gains tax. RSUs are taxed when vested.

What happens to RSUs when an employee leaves the company?

When an employee leaves, any unvested RSUs are typically forfeited. Vested RSUs, however, remain the employee’s property and can be sold or held.