As a founder, understanding equity compensation is essential for the benefit of your employees and the health of your company stock. Properly structured equity compensation helps you align employee interests with company success and helps manage your cash flow while offering a competitive compensation income.
Over the past decade, startups and larger companies have been redefining their corporate stock equity awards in response to the evolving securities laws. Restricted Stock Units (RSUs) and Restricted Stock Awards (RSAs) are emerging as viable alternatives to traditional types of options like ISOs and NSOs. Unlike stock options, which give employees the choice to purchase shares of stock at a predetermined purchase price, RSAs and RSUs are outright grants of stock. While employees typically do not pay anything upfront, they must meet specific vesting conditions before they fully own the shares.
Although RSAs and RSUs might seem to be identical at first glance, there are several distinctions between the two. This blog covers the differences between RSAs and RSUs to help you optimize the structure of your stock option offerings.
What are Restricted Stock Awards (RSAs)?
Restricted Stock Awards (RSAs) are a form of equity compensation offered to certain employees by their employers with high upside potential. RSAs are typically awarded to incentivize employees and align their interests with the company’s success. When an RSA award is granted, the employee gains immediate ownership of a set number of shares, subject to certain vesting restrictions.
Before an employee can fully reap the benefits of Restricted Stock Awards, they must fulfill certain conditions. These RSA vesting requirements often relate to achieving specific performance goals or completing a certain period of service. Restricted Stock Awards are regarded as a form of ‘restricted stock’ as the employees are not allowed to transfer or sell the shares freely.
Two primary types of taxes are linked with this equity compensation - ordinary income tax and capital gains tax. If an employee keeps the stock for more than a year before selling it, any increase in the value of the stock is taxed at the long-term capital gains tax rate, which is applicable at a lower rate than the ordinary income tax rate.
Key Features of Restricted Stock Awards (RSAs)
Here are some key features of RSAs:
Voting Rights: With RSAs, employees gain voting rights from the grant date, which distinguishes it from other forms of equity compensation. RSAs give employees the opportunity to actively engage in shareholder decisions, exercise their voting rights, and influence the company’s direction.
Immediate Ownership: As soon as the RSAs are granted, the employee becomes a shareholder. The immediate ownership aspect of the award can act as a strong incentive for employees. They have a direct interest in the company’s prosperity and stand to gain from any rise in the stock’s value. However, it is important to note that while the employee becomes an immediate shareholder, they cannot trade the shares until the restrictions, such as vesting conditions, are lifted.
Dividends: Upon receiving an RSA, an employee becomes a shareholder and gains the right to receive dividends, just like any other shareholder. Dividends, usually distributed from the company’s earnings, are given out in proportion to the number of RSA shares owned by the employee. This provides an additional financial benefit to employees, over and above the potential appreciation of the stock value.
What is a Restricted Stock Unit (RSU)?
A Restricted Stock Unit (RSU) is another type of equity compensation that companies issue to employees. An RSU is a promise from your company to give employees shares of the company’s stock (or the cash equivalent) on a future date as soon as they meet certain vesting conditions (based on performance milestones or a specific length of service).
You can use RSUs to incentivize employee retention and encourage long-term commitment to the company. RSUs have gained popularity since the mid-2000s, following accounting scandals involving prominent enterprises like Enron and WorldCom, as a means of attracting and retaining talent.
Here are some key features of RSUs:
Taxation: Once RSUs vest, they are treated as income, and a portion of the shares is set aside to cover ordinary income tax. The employee then receives the rest of the shares and is free to sell them.
No Risk of Underwater Options: In contrast to stock options, which can lose all their value if the stock price goes below the strike price, RSUs maintain some worth unless the price drops to zero. This makes RSUs a less risky form of equity compensation for employees.
Flexibility in Settlement: RSUs offer flexibility in how they can be settled. Depending on the company’s plan rules, RSUs can be settled in company shares or the cash equivalent. This provides employees with options when it comes to realizing the value of their RSUs.
Comparing RSAs vs RSUs
Here is a comparative analysis of RSAs vs RSUs to help you select the best equity compensation option for your team members:
Ownership of RSAs vs RSUs
Restricted Stock Awards (RSAs): When an RSA is granted, the employee becomes an immediate owner of the awarded shares. This ownership is subject to vesting conditions, which means the employee must fulfill certain requirements before they can sell or transfer the shares. Despite these restrictions, the employee has the same rights as any other shareholder, including voting rights and the right to receive dividends.
Restricted Stock Units (RSUs): RSUs represent a promise from the employer to deliver shares or the cash equivalent at a future date. The employee does not receive actual shares until the RSUs vest, which typically occurs after a certain period or upon achieving specific performance milestones. Until the RSUs vest, the employee does not have any shareholder rights.
Tax Treatment of RSAs vs RSUs
RSAs: Understanding RSA’s taxable events is one of the important factors in determining the tax obligations of the holder. The tax implications of these equity compensation awards are as follows:
At Grant: If an employee makes an 83(b) election within 30 days of the grant date, they can pay taxes based on the Fair Market Value (FMV) of the stock at the time of the grant. This can be beneficial if the stock’s value is expected to rise significantly during the holding period.
At Vesting: If no 83(b) election is made, the employee is taxed at the time the shares vest. The taxable income is the difference between the fair market value of the stock at the time of vesting and the amount paid for the shares, if any.
RSUs: RSUs are taxed at vesting. The value of the shares at the time they vest is treated as ordinary income and comes under the purview of federal income tax and payroll taxes. Unlike RSAs, there is no 83(b)-election option for RSUs, making the significant tax burden unavoidable at the end of the vesting period.
Voting Rights of RSAs vs RSUs
RSAs: Since RSA recipients become immediate owners of the stock upon grant (even if subject to most common vesting conditions), they generally have the same rights as any other shareholder, including voting rights. This allows employees to participate in company decisions, further enhancing their sense of involvement and commitment.
RSUs: Until the RSUs vest and actual shares are issued, employees do not have any of the rights of stockholders. Employees only gain voting rights once the shares are delivered upon vesting. This means that until vesting, employees with RSUs do not have a say in company decisions.
Vesting Conditions of RSAs vs RSUs
RSAs: Vesting conditions for RSAs can include time-based vesting, where the employee earns the right to the shares over a period of time (e.g., four years with a one-year cliff), or performance-based vesting. This means that an employee must remain in your company for a certain period or achieve specific goals to access the value of the RSAs.
RSUs: RSUs also have vesting conditions, which can be similar to those of RSAs. Time-based vesting is common, but RSUs can also be tied to performance metrics. Herein, only if the performance of the individual is as per expectations, will they get full ownership of their full equity grant. This provides companies with flexibility in how they incentivize and reward their employees.
Employee Impact of RSAs vs RSUs
RSAs: The immediate ownership aspect of RSAs can be highly motivational for employees. Knowing they already own a stake in your company, even if they cannot yet sell the shares, can foster a strong sense of alignment with the company’s goals and performance.
RSUs: RSUs are simpler for employees to understand and manage. They do not need to worry about making tax elections at the time of grant, and the tax event is straightforward at vesting. This simplicity can make RSUs a more attractive option for employees who prefer a straightforward equity compensation plan.
Conclusion
Choosing between RSAs and RSUs or using a combination of both is not easy. Each form of equity compensation has its own set of implications, including tax consequences, impact on employee motivation, and influence on ownership structure.
Managing these equity awards can be complex and time-consuming as it involves tracking vesting schedules, handling tax withholdings, and maintaining accurate records. At Qapita, we understand the challenges startup founders face in such situations and simplify your equity management issues by automating workflows around CapTables, ESOPs, due diligence, and transactions.
We offer robust Equity Management Software rated as #1 by G2 for managing your ownership needs, efficient equity workflow management, and a structured marketplace to offer liquidity to stakeholders. With Qapita, you can easily handle all equity-related matters for your company, from inception to IPO.
Our platform is trusted by over 2,400+ companies and 300,000 employee-owners. Whether you are grappling with RSAs, RSUs, or any other aspect of equity management, Qapita has the expertise and experience to serve you
