Employee stock options can have unlimited earning potential, but RSUs tend to have more certainty that you’ll at least get something from this equity comp.
If you’re applying for tech jobs and trying to decide between two offers — one with RSUs and one with options — which one should you choose? Or, if you already have stock options at your current company, for example, is it worth it to forego those for a new job offer that includes RSUs?
While there’s no easy answer, in this article, we’ll explore restricted stock units (RSUs) vs. options in more detail to help you understand what these stock grants mean and which one could be more lucrative for you once you reach your grant date.
An RSU is a type of equity comp, where companies agree to provide employees a certain value in stock following a vesting period. For example, you might get an RSU offer worth $50,000. That means that once you fully vest, i.e., stay at the company long enough, you can receive company shares equivalent to $50,000. In that case, the exact number of shares will vary based on stock price fluctuations.
Public tech companies often use RSUs, as you can easily obtain publicly traded stock that has a defined value. But there can be cases where private companies offer RSUs, such as those that will soon have an IPO, explains Carta, an equity management solutions company.
While RSUs often have a clear cash value, they are not cash equivalents, as they lack the same liquidity as cash. RSUs at private companies can not be traded on the open market, so you would generally need to wait for a liquidity event. And RSUs at public companies may be easier to eventually sell, but there are still restrictions.
“The grant is ‘restricted’ because it is subject to a vesting schedule, which can be based on length of employment or on performance goals, and because it is governed by other limits on transfers or sales that your company can impose,” explains financial services firm Schwab.
An employee stock option is an offer to purchase company stock in the future at a set price. This price, known as the exercise or strike price, is generally set based on the fair market value of the company at the time of the grant.
For example, a startup might provide employee stock options that allow you to purchase 1,000 shares at $10 per share, following a vesting schedule. You don’t have to exercise those options, however, such as if the stock price ends up falling below $10 per share, making the options worthless. But maybe you get lucky and the startup grows significantly since the time the stock option strike price was set.
Suppose the stock price rises all the way to $50 per share. In that case, once vested, you could pay $10,000 to exercise your options (1,000 shares at $10 per share), which translates into getting company stock worth $50,000 (1,000 shares at $50 per share).
Both RSUs and stock options are means of compensating employees with stock, but there are some significant differences. Some of the top contrasts include:
RSUs often have a set value at the time of the initial grant (e.g., $50,000). RSUs granted as a set number of shares can have more fluctuation in value, but as long as the stock price is above $0, RSUs retain value.
The value of stock options depends on the stock price in relation to the exercise price. If the stock price is less than the exercise price, the options have no value. If the stock price is above the exercise price, the options have a value based on the difference between these levels.
RSUs generally have more security in the sense that for RSUs provided based on a set value, even if the stock price declines, employees know they can cash in at the same value they were granted.
For grants based on a number of shares, employees can still cash those shares in for the current market price, even if the price declines (as long as it stays above $0).
Stock options have less security in the sense that a stock price decline could make them worthless.
Even a slight decline, say, going from $100 per share to $99 per share by the time an employee vests, means that the employee would lose money if they exercised the options, so they would need to wait to see if the stock price rises above the strike price.
As a tradeoff for security, RSUs generally have more restrictions. In addition to vesting schedules, employees have limited windows when they can sell stock from RSUs, even after vesting.
So, there can be a risk that stock market swings will occur during those restricted periods, which can make it hard to optimize when to sell.
Stock options generally have fewer restrictions than RSUs, but it depends on the type:
The full value of RSUs is taxed as ordinary income once vested, so your tax bill could be quite high.
Additional earnings from stock price gains once you own the shares would be subject to capital gains taxes.
Taxes depend on the type of stock option:
The choice between RSUs vs. options can depend on factors such as the maturity of a company and the compensation it wants to provide employees.
As Diligent Equity, an equity management solutions company notes, early-stage startups tend to be the ones more likely to provide stock options.
“Early on, options make sense for a company because of the relatively low strike price and higher anticipated growth rate,” adds Carta.
In contrast, later-stage companies would be more likely to offer RSUs. Some of the most well-known, publicly-traded tech companies offer RSUs. That can be helpful for employees at these companies, where the stock price might not have as much upside as it used to. Yet the RSUs can still retain significant value even if the stock price stays the same or even declines since the initial grant, particularly if the company makes the grant as a set dollar amount.
Taxes can be a tricky area for any type of stock grant, and it’s important to understand the differences so that you can better assess the full value of RSUs vs. options and optimize your financial planning.
With RSUs, one downside is that you’ll generally owe ordinary income taxes on the full value received after vesting. If you made $100,000 in salary one year and also took ownership of $100,000 worth of stock based on vesting RSUs, then you would be taxed on $200,000 in earnings that year. So, you may need to sell some stock to cover your taxes. Keep in mind any restrictions you might face around selling periods.
Stock option taxes depend on whether you receive NSOs or ISOs. With NSOs, you would owe taxes after exercising your options based on the difference between the market price and strike price. As in the earlier example, if your strike price was $10 per share for 1,000 shares, that would equal $10,000. And if the market price at the time of execution was $50 per share for 1,000 shares, that would equal $50,000. So, you would owe income taxes on this $40,000 spread between these two amounts.
For both RSUs and NSOs, once you actually own the stock, any additional gains would be based on capital gains rates. So, if you hold the stock for more than a year before selling, you could pay the long-term capital gains rates, often 15% or 20% for high-income earners, which tends to be much lower than income tax rates.
With ISOs, if you meet the required holding period before selling shares (generally the later between holding for at least two years following the initial grant or one year after the stock was transferred to you), then all of the gains, including the spread between the strike price and market price, would be treated as capital gains. That said, the spread comes into play when determining if you owe the alternative minimum tax.
The short answer is that neither RSUs nor stock options have voting rights.
The longer answer? Both RSUs and stock options involve the future delivery of shares, rather than employees actually owning stock at the time RSUs or stock options are granted. Instead, you have to wait for the shares to be transferred to you or to exercise your options, generally following a vesting period. So, until you actually own the shares, you don’t have any stock voting rights.
Like with voting rights, since no shares are actually owned before vesting/exercising, then neither RSU nor stock option holders are eligible for dividends.
That said, some companies do pay RSU holders an equivalent amount as to what they would have earned in dividends had they owned the actual shares the whole time. These payments, known as dividend equivalents, can be made to employees either at the same time the actual dividend occurs (which is often paid out in cash) or when the RSUs vest (which is often paid out in additional stock), as the National Association of Stock Plan Professionals (NASPP) explains.
So which is more lucrative — RSUs or stock options? Unfortunately, it’s not always clear-cut.
In theory, stock options have unlimited potential; you might have an exercise price of $10 per share, but maybe the stock price soars to $50, $100 or even more per share. However, if the stock price falls below the strike price, your options are worthless until/unless the price rises.
With RSUs, if you get a stock award for a set number of shares, similar logic applies regarding potential, though at a later-stage company growth may be less exponential. Still, you don’t have a strike price to worry about. And if you’re granted RSUs based on a set value, say, $50,000 worth of stock, then you know you’re going to get that same amount once vested, regardless of stock price changes.
With that in mind, RSUs are perhaps more lucrative in the sense that there’s likely to be at least some guaranteed value. In contrast, you might not have an opportunity to cash in on your stock options, especially if there’s no path to liquidity for the company.
That said, stock options could potentially become more lucrative. If you catch the right wave at an early-stage startup, you could have a very low strike price and ultimately cash in at a much higher market price down the road, such as if the company has an IPO.
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