RSU (Restricted Stock Units) are an increasingly popular instrument among share based compensation. We outline the basic principles as well as differences to classic stock options.

RSU Granting and ownership

RSU illustration

RSU

When the company grants an employee equity-settled RSUs, the employee receives a promise to obtain a specific number of company shares in the future. They don’t actually own the shares until the vesting conditions are met. The value is typically tied to the company’s stock price. Cash settled restricted stock unit entitle employees to receive a cash payment equal to the share price at the exercise date.

Stock option (ESOP)

Classic stock options grant employees the right to purchase a specific number of company shares at a predetermined strike price. However, the employee doesn’t actually own the shares until they meet the vesting conditions.

XYZ Corporation Restricted Stock Unit (RSU) Plan

RSU Purpose and Objectives

The XYZ Corporation RSU Plan serves the purpose of providing a long-term incentive to eligible employees. As a result, we align the interests of the beneficiaries with the company’s success and promote employee retention. The plan aims to reward and retain top talent, driving the company’s growth and profitability.

Eligibility

All full-time employees of XYZ Corporation are eligible to participate in the Plan. Eligible employees include executives, managers, and other staff members as determined by the Compensation Committee.

RSU Grants

  • Compensation Committee (CC) will determine the grant of RSUs to eligible employees.
  • It will also base the number of RSUs granted to each employee on factors such as job performance and position.
  • RSU grants will be subject to a vesting schedule specified at the time of the grant.

Vesting

  • Instruments will vest according to the following schedule: [Insert vesting schedule, e.g., 25% after one year, with the remaining 75% vesting quarterly over the subsequent three years].
  • CC may accelerate vesting upon certain events, such as a change of control or retirement.

Dividend Equivalents

Participants in the RSU Plan will receive dividend equivalents, which the CC will pay out in cash upon the vesting of units. These equivalents will be paid out in cash, as determined by the Compensation Committee, upon the vesting of units.

Forfeiture of RSU

An employee who terminates employment before RSUs vest will forfeit any unvested RSUs, except for cases outlined in the individual grant letter. These exceptions will be outlines in die individual grant letter.

Taxation

Upon vesting, we will treat the fair market value of vested unit as ordinary income for tax purposes, subject to applicable tax withholding. Subsequent gains or losses when selling shares will be subject to relevant tax laws and treated as capital gains or losses.

Ownership and Voting Rights

Upon vesting, employees will have ownership rights and the ability to vote at shareholder meetings for shares acquired through restricted stock units.

Amendment and Termination

Board of Directors or the Compensation Committee may amend or terminate the XYZ Corporation RSU Plan at any time, based on legal requirements and any applicable agreements with participants.

Administration

The Compensation Committee of the Board of Directors will oversee the administration of the Plan. this includes the grant of RSUs, determination of vesting conditions, and any necessary adjustments or interpretations of the plan.

Sample RSUs

Vesting

RSUs often have time-based vesting. This means the employee must remain with the company for a certain period before they receive the shares. Once the vesting period is complete, the employee receives the actual shares.

Stock options may have both time-based and performance-based vesting conditions. Typically, employees need to work for the company for a specific duration (vesting period) and sometimes meet performance targets before they can exercise their options and purchase shares.

Taxation for RSUs is relatively straightforward. When the units vest, their fair market value is typically treated as ordinary income and subject to income tax. Subsequent gains or losses when selling the shares are typically treated as capital gains or losses.

The tax treatment of stock options can be more complex. When stock options are exercised, the difference between the exercise price and the market value of the shares is often subject to income tax. Gains or losses upon selling the shares are typically treated as capital gains or losses.

Taxation

Risk and reward

RSUs provide employees with a guaranteed value, assuming they vest. There is no financial risk involved for the employee, as they receive the shares once the vesting conditions are met.

Stock options offer the potential for significant financial gain but also come with the risk of being worthless. This ist the case if the company’s stock price falls below the exercise price. Employees have the choice to exercise the options or not, depending on the stock’s performance.

RSUs usually provide liquidity to employees upon vesting since they receive actual shares of the company’s stock.

Stock options may not provide liquidity until they are exercised. Employees need to come up with the funds to purchase the shares at the exercise price.

Liquidity

Cash vs. equity settled RSU

Equity settled RSUs securitize the right to receive genuine equity instruments upon exercise or upon reaching maturity.

In contrast, cash settled RSUs securitize the right to receive a cash payment in the amount of the respective share price at the time of exercise or at the end of the term.

In summary, RSUs are simpler to understand and typically involve less financial risk for employees. Stock options offer the potential for greater financial rewards but come with more complexity and uncertainty. The choice between restricted stock units and stock options often depends on a company’s compensation philosophy, its stage of growth, and the goals of the employees.

For any other types of share-based compensation, please visit our special website within the knowledge center. For pros and cons of RSUs checkout investopedia.