Restricted Stock is a popular way to incentivize employees. There are two stock bonus structures – restricted stock units (RSU) and restricted stock awards (RSA). Both can be a fantastic incentive but they have important differences that may affect your financial plan. Below we are going to discuss RSU vs RSA and the differences that you need to know about.
How do restricted stocks work?
The easiest way to understand how restricted stock works is that they are restricted as you still have to earn them after they are issued. A common restriction is a vesting schedule which means that the shares are earned over time. This incentivizes employees to stay with the company longer. Restricted stock is usually offered by young companies who cannot afford to pay their employees a high salary yet. There are two types of restricted stock – restricted stock units and restricted stock awards.
What are restricted stock awards (RSA)?
A restricted stock award is a type of restricted stock. You are ‘awarded’ stock when you join the company and immediately become a shareholder with voting rights. If you have an RSA, then you own the right to purchase shares of your company’s stock at a set price, or you own the right to claim a set number of shares for free. RSAs are given on the grant date (usually when you start a job) but restrictions, such as a vesting schedule, still apply.
Pros of RSAs
- Grant date: You are generally granted the stock as soon as you join the company.
- Shareholder: As soon as you are granted the stock you become a shareholder and have voting rights.
- 83(b) election: You can make an 83(b) election which can greatly reduce your taxes.
Cons of RSAs
- Upfront payment: You have to provide payment to purchase the RSA shares at grant date (either at fair market value, at a discount, or at no cost)
What are restricted stock units (RSU)?
An RSU is much simpler than a RSA. A restricted stock unit (RSU) is compensation given to an employee as company stock without needing to pay for them. The RSU stocks are received later when the vesting is complete. They are offered to employees through a vesting plan and distribution schedule.
The employee doesn’t own them or become a stockholder with voting rights until all of the requirements in the plan have been met. These requirements could include staying with the company for a particular amount of time or achieving performance milestones. When an RSU is granted, it gives employees interest in the company’s stock but there is no tangible value until the vesting is complete.
Pros of RSUs
- Long term incentive: Employees are incentivized to stay with the company longer and put more effort into growing the company so that they get the highest possible value for the stock.
- Low-impact: RSUs require minimal managerial work.
Cons of RSUs
- No dividends: RSUs do not provide dividends while they have not yet vested.
- Shareholder voting rights: There are no shareholder voting rights until the shares are fully vested.
- No tangible value until the shares vest and restrictions lapse.
What is the difference between RSAs and RSUs?
RSAs and RSUs are both restricted stocks but they have many differences. An RSA is a grant which gives the employee the right to buy shares at fair market value, at no cost, or at a discount. An RSU is a grant valued in terms of company stock, but you do not actually get the shares until the restrictions lapse or vest. As soon as the conditions are met, then the employee will receive the shares in the form of stock or cash.
– Taxes: Two types of taxes are relevant for restricted stock – ordinary income tax and capital gains tax. Taxation of RSAs and RSUs can be complicated. RSAs are bought on the grant date and any taxable gain between the grant date and vesting is subject to ordinary income tax. Once the shares vest, any subsequent gain between vesting and sale is subject to capital gains tax.
RSUs are not purchased so they are only taxed (as ordinary income) once the shares are granted after it vests.
– Vesting: RSAs have time-based vesting conditions and RSUs have a lot of vesting conditions until the employee becomes the owner of the shares. The person who gets RSA shares owns them, however the vesting for RSAs affects whether the company can repurchase the shares if the person leaves the company. Many companies have a vesting schedule to avoid a case where an employee joins the company, gets their RSA and then immediately leaves the company.
RSU shares aren’t issued to the employee until they vest. The company grants the RSU with a vesting schedule and promises to deliver those shares later as per the vesting schedule.
– 83(b) election: RSAs are eligible for the 83(b) elections which can see a future tax bill greatly reduced. RSUs are not eligible for the 83(b) elections. The 83(b) election is when an employee can choose to pay all the ordinary income tax upfront for the RSA. The deadline to file an 83(b) election is 30 days from the grant date so keep that in mind.
– Settlement: The settlement for RSUs can be in stock or in cash. The settlement for RSAs must be in stock.
– Entitlement to dividends: For RSUs, there is generally no entitlement to dividends or voting rights. For RSAs, you are entitled to dividends and voting rights.
– Termination: If you leave a company before the shares of your RSU or RSA have vested, then things can be a little complicated. Unvested RSA shares are subject to repurchase upon termination and unvested RSU shares are forfeited back to the company upon termination.
Which type of restricted stock is right for you?
While there are many similarities between RSAs and RSUs, there are also many differences that we highlighted. Ultimately the decision comes down to what you think is best for your financial situation. At District Capital Management, we work with a variety of clients who have RSUs or RSAs as part of their compensation package. If you are interested in a comprehensive financial plan with RSUs or RSAs recommendations, schedule a free discovery call with one of our financial advisors today.
