Explainer: performance stock units

In my third “explainer” article, I offer insight on performance stock units (see here for an explainer on restricted stock units, and here for an explainer on stock options). Performance stock units (PSUs), are to me the most interesting form of equity compensation because they add an additional performance component on top of stock price performance. This means their potential payout range can be wider than other forms of equity – both on the low side and on the high side.

PSUs are one form of compensation where I believe if you understand them well, you can often powerfully negotiate for more or better terms, which can have a meaningful impact on your take-home pay. Additionally, you can better assess their value and how hard it may be to achieve payouts. My goal is to help women better understand these units so they can feel more confident in negotiating them. Every step forward in individual negotiations is a step forward in closing the gender pay gap seen in equity compensation.

Performance Stock Units 101

Similar to restricted stock units (RSUs), PSUs can be made up of real shares or notional shares. Real shares mean you receive real stock units of the company, whereas notional shares mean you receive a cash amount that tracks the share price of the company. PSUs are also similar to RSUs in that you automatically receive the value when they “vest” (become yours), whereas with stock options you have to action them yourself to receive value. Lastly, each PSU you receive is typically equal to the value of one share on the day they were granted to you. However, on the day they vest, their ultimate value is dependent on achievement against a performance metric.

There are many different ways PSUs can be structured to take into account performance conditions, similar to different bonus plan designs. Companies build these plans around their individual strategies and the financial metrics that are most important to them. Below I have outlined one typical structure as an example.

Example: 3,000 PSUs were granted to you on March 1, 2022 when the company share price is $10. In most cases, this means the PSUs are worth $30,000 (3,000 x $10 = $30,000) at that point in time.* The PSUs have a performance metric that states:

• If company revenue hits $1M in two years from grant, you will receive 100% of the units. (target payout)
• If company revenue hits $0.75M or less in two years from grant, you will receive 50% of the units. (minimum payout)
• If company revenue hits $1.25M or more in two years from grant, you will receive 150% of the units. (maximum payout)

At the end of two years, your PSUs vest. The company has had great performance, achieving revenue of $1.3M and a share price of $20. This means the performance metric has been exceeded (revenue is above $1.25M), so you will receive 150% of the units (3,000 x 150% = 4,500 units). These 4,500 units are now worth $90,000 (4,500 x $20 share price).

If your company is publicly listed and you were granted real share units, in most cases you can sell all or a portion of these units on the market and take home that cash (excluding tax considerations), or you can choose to hold them longer if you think the share price will keep increasing. If your company is private, you may not be able to sell them, but you now have real ownership in the company. If you were granted notional shares, you now have access to the $90,000 worth in cash (excluding tax considerations).

*Note: if the performance condition is set high enough that it is unlikely to achieve target payout, PSUs can be valued at less than one share on grant.

Some Notes & Tips:

These notes and tips explain at a high level some of the technical aspects and considerations of PSUs, to help familiarize you with key terms and concepts.

• Structure: PSUs can be structured in numerous ways, and they are often individualized to the company’s goals and strategy. Another common structure (beyond the example provided above) is annual vesting with annual performance metrics. For example, you are granted 3,000 PSUs that vest equally over three years (1,000 units per year) and each year, financial performance is assessed against a certain performance threshold to determine how many PSUs you will receive in that year. Note that PSUs can also be linked to non-financial metrics, including individual performance and strategic goals. Lastly, there are structures that provide a slight modification to the payout at the end of the performance period (called a modifier), instead of having a financial metric built into the entire payout calculation.
• Risk profile: PSUs are typically equal to one share, meaning they are less risky than stock options (stock options only have value if the share price increases from the date they were granted on). However, some PSUs can have performance conditions with payout ranges that go as low as 0% if a certain metric is not achieved. While not all PSUs have this downside risk, it is important to understand the structure of your PSUs to know how much risk you are taking on. Most often, PSUs are riskier than RSUs given they have the potential for lower payouts, but also have the potential for higher reward.
• Vesting period: PSUs most commonly vest over three years, meaning you will not see any value until 1-3 years in the future. However, companies are becoming more creative with PSU structures, with some creating 1 year PSUs for shorter-term achievements, and others creating 10 year PSUs for a longer-term view. Ensure you understand what the vesting schedule is, especially if you are comparing two offers with different equity structures.
• Actioning: similar to RSUs, if you are granted real share units in a public company, you do not have to sell the shares right when they vest. If you believe in the company, you can choose to hold the shares over the longer term and sell them at a future date (with hopefully a higher share price).
• Plan text & equity agreements: PSU agreements are especially important to read as they should clearly outline the performance metrics and how they work under different scenarios. Understanding this in detail can help you determine how likely it is that you will receive value from the units. Some companies intentionally make PSUs hard to achieve (i.e., “stretch goals”) to motivate management teams to push beyond the day-to-day. If you are uncertain how hard the conditions are, ask questions about historical payouts. Additionally, review and ensure you are comfortable with the other terms, including termination conditions, grant cadence, valuation, etc.
• Tax: taxation of PSUs can be different based on your location, if your employer is public or private, if you are getting real or notional shares, and how the performance conditions are structured. Similar to RSUs, in North America PSUs are often taxed on vest and again when you sell the shares, but there can be nuances that change this. Understand when the taxable events are and what the type of taxation is (employment income or capital gains) – and if you are making a material amount of compensation in PSUs, ask a tax expert so there are no surprises.

PSUs are a more complex type of equity compensation as their design is individualized to the company, and they can be structured in many different ways. It is worth it for you to take the time to understand them, and leverage advisors if you need. Thoroughly understanding PSUs will help you feel empowered to negotiate for more. If you have any questions about your individual PSU structure (or equity compensation in general) please reach out to The Thoughtful Co at [email protected] or book an introductory call here.