Restricted Stock Units: an explainer

Hello friends,

Today we're talking about Restricted Stock Units (RSUs from here on out), what are they, why they matter, where things can get tricky, and what you can do with them. It's a classic Big Later Good Time (BLGT from here on out).

Note: this first section is all about RSUs at publicly traded companies. I'll circle back to privately held company RSUs at the end (things are a bit more complicated there, but not so complicated that we can't cover it adequately in a few paragraphs).

RSUs are a form of equity that an employer can grant to an employee

They're basically the employer saying, "Hey, you are an important employee and we want to recognize that by giving you stock in the company" — that kind of sums up the "Stock Units" part of the acronym. This can be a lucrative deal, particularly if the company is performing well and the stock price is rising.

Ah, if only it were so simple as an employer giving stock to a deserving employee. The nuance is in the "Restricted" part.

Employers like their strings exactly how I like my arms: attached.

So they're not just gonna give you all that stock right upfront. RSUs, when granted, typically become available to you in increments over a predetermined period of time. This is the "vesting schedule". Example? Sure.

Let's say your employee gives you a grant of 100 RSUs that will vest "quarterly after a 1-year cliff" (this schedule is pretty common). That means that you get nothing until 1 year has elapsed, then you get a big chunk (25%) and the remaining 75% will vest in 6.25% increments each quarter until the full grant has vested. See my fun little table below:

(Take a moment to appreciate the retention tactics at play here; if your employer grants you RSUs, that's basically additional quarterly income on top of your salary. The longer you stay at the company, the more stock you "unlock". It's not a bad system.)

So that's kind of the gist of it. Your employer rewards by dripping out equity over a period of years. At each vesting point, that portion of stock becomes yours. You are free to do whatever you like with it – hold, sell, or a combination of both. Simple, right? Well, hold on a second...

Let me ask you something

What does the government like to do when we make money?

Here's a hint: it rhymes with "inspect axes"

Still working on it? The answer was "collect taxes".

RSUs are treated as regular income that is equivalent to the value of the shares on the day they vest.

In the eyes of the IRS, at each vesting point, you are receiving a cash bonus on top of your regular salary. That means taxes. Not fun, but part of life.

A common practice is to sell back a portion of your stock to cover the taxes you owe on this income (in many cases, this happens automatically). But that’s not all.

Because this “income” comes in the form of stock, you’ll also have to pay capital gains taxes. Fortunately, you'll only be on the hook for gains accrued after the vesting date. If you sell all your shares immediately after they vest, this is basically just padding your income with cash. Very low-risk.

If you do decide to hold on to some (or all) of your stock...

Keep in mind that you’ll owe capital gains whenever you do end up selling. The standard rules apply here: hold for less than a year, and you’ll pay the short-term capital gains rate. Longer than a year, and you’ll pay the 15% long-term rate.

The big question: when shares vest, do you sell or hold?

That will depend on a number of factors including your savings/life goals, your confidence in the company's long-term performance, and your risk tolerance. I sold some RSUs one time to fund a personal project (it was a pressurized hydration system for gravel cyclists who enjoy rides that are longer than 5 hours... talk about niche!). I also sold a big chunk of RSUs to give myself the financial runway to work on Big Later full time (we'll see how that pans out...).

If you do choose to hold, just remember the importance of diversification. Having a large percentage of your net worth tied to a single stock is inherently risky – no matter how great the company is.

Note: not everyone can sell RSUs whenever they want. Some employers subject their RSU-holding employees to specific "trading windows" or "blackouts" — not sure whether this applies to you? Check your RSU grant documentation (or ask someone in HR).

Let's wrap this up with some comments about RSUs at privately held companies

The bones are about identical: your company gives you an RSU grant that vests over a period of time and you have to pay taxes every time a chunk of shares vest. Here's the catch: if your shares vest while the company is still private, you'll have to pay taxes but you won't be able to sell shares to cover the costs (because the company is private). So you're on the hook for a (potentially) sizable tax bill that you'll be paying cash to cover.

Let me get this straight...

I have to pay cash (which has already been taxed as income) to cover the taxes on stock (that might never be worth anything) because the IRS is treating it as income? That hurts!

Most private companies see the issue and have decided to do something about it

They do this by having a “double trigger” vesting requirement. It's a workaround which means the shares aren’t really truly yours until two conditions are met:

1. The shares vest, AND
2. The company goes public (or some other liquidity event occurs that turns the shares into money)

This is incredibly common in pre-IPO companies. Way to go, pre-IPO companies!

So there ya have it folks, RSUs in a nutshell

If you have them, assess your risk tolerance, goals, and portfolio composition when making sell/hold decisions. If you don't have them (but your company offers them), consider how you might position an RSU grant in your next promotion conversation. And if you're between jobs but looking at public companies, make them a part of your salary negotiation.

See you soon!