Restricted Stocks Units (RSUs) are the most popular type of equity compensation. Here in the Pacific Northwest RSUs often make up a large percentage of high earners compensation. RSUs are essentially just compensation paid to an employee in the form of company shares.
Grants of RSUs are subject to a vesting schedule generally based on length of employment (but occasionally based on other factors such as performance goals). Thus the employee has to wait until either the time passes or performance goal is met before they actually receive the RSUs as compensation. The actual amount of RSU compensation will fluctuate along with the performance of the company’s shares in the market. For those working at companies that have seen significant growth in their share price this can create a significant increase in the compensation they receive from their RSUs over time as compared to the value of the shares at the initial grant date.
RSUs are a relatively simpler form of equity compensation. Unlike stock options there is no analysis needed to determine when to exercise. And unlike other restricted stock there is no option to make an 83b election for tax purposes.
RSUs are taxed when you receive the shares based on the market value of the shares at the time of vesting. It’s important to know how tax withholding will be handled at the time the shares vest so that you don’t face a surprise tax bill down the road.
Should I sell my vested RSUs?
From a planning perspective, RSUs should be thought of as a cash bonus when they’re received. There’s no tax impact to immediately selling the vested shares. Thus an employee should consider their vested RSUs as a cash bonus. The question then is whether the company’s stock is something the employee would choose to invest that bonus in upon vesting. If an employee doesn’t typically invest in individual equities and do proper due diligence into investing then I think it’s generally a good policy to sell their RSUs as soon as they vest. Most employees are already heavily tied to their employer’s fortunes so from a planning standpoint it generally isn’t wise to add risk exposure to that company by tying a large chunk of your net worth into the Company’s stock.
Selling your RSUs may be easier said than done though. As JP Morgan said, “Nothing so undermines your financial judgement as the sight of your neighbor getting rich.” Those who work at employers whose stock has done well in the past decade may find it very tempting to hold onto their company’s shares. Employees who have held on to company stock at places like Amazon and Microsoft have done exceptionally well the past decade. Seeing coworkers and friends making a lot of money can make it hard to practice proper risk management. But for every success out there I think it’s important to keep in mind there’s also been catastrophic failures such as Enron. Many of Enron’s employees had a significant portion of their net worth invested in the company so when it went under not only did they lose their job but they saw much of their net worth wiped out along with it. Before it went under, Enron was a high flier in the stock market and many of its employees thought that the prospects for the company looked promising. So… caveat emptor.
For those who have built a large position in a single company’s stock I think it’s important to develop a plan moving forward. For instance one could sell down that stock over a period of years to help with the fear of missing out on the company’s success if it does well. Without a plan it’s too easy to get tied up emotionally into the company. If the stock does well many will be emboldened to hold onto it without a plan and thus increase their risk and exposure to the company even more.
Private Company RSUs
There are some additional challenges/considerations for employees of privately held companies that receive RSUs. Most private companies that issue RSUs have added a double-trigger vesting schedule. In addition to the normal time (or performance) requirement, shares do not vest until there is some liquidity event (i.e. an IPO or acquisition).
When restricted shares vest in a private company you still owe ordinary income taxes on the amount, which can be problematic as you generally have no way to sell shares to cover those taxes. One option available to some employees is to make an 83(i) election, which allows you to defer those taxes for up to 5 years.
Details can differ from company to company so it’s important to be familiar with the nuances of any RSUs you receive in your company. If you have any questions or would like help reviewing your situation please feel free to reach out.
Scott Caufield, CFA, CPA