RSUs vs Options - Everything you Must Know
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You should look at more than just the employer's dollar amount when you get a new job offer. Most employers offer other benefits that won’t show up in your paycheck but could be beneficial monetarily speaking down the road.
Two common forms of non-monetary compensation are RSUs and stock options. While they are both common, they are very different from one another. Understanding the differences can help you choose the right compensation plan for you.
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Understanding Why Employers Compensate in Equity
Many people aren’t familiar with the reasons for compensation in equity. For example, wouldn’t employees rather have cold, hard cash than company shares in stock options?
While it would seem that way, there is something to be said about employee performance when they have a ‘stake’ in the company. When you’re awarded equity in the company, you’re more likely to work harder, and most companies offering equity outperform those that don’t offer it.
It’s likely due to the mindset it creates. When you have a vested interest in a company other than a paycheck, you’re more likely to look out for the company’s best interests. When you don’t have ‘skin in the game,’ you’re more likely to view the company as lining the owner’s pockets and not your own. You may not work as hard as a result.
What are Stock Options?
A common form of equity employers offer is employee stock options. These assets give you the ‘right’ to buy stock at a specific price within a specific term. Most commonly, employers offer stock options with the right to buy the stock at the current market price at a future date.
The future ability to buy stocks at a lower price often creates motivation or longevity in employees. If you know you can invest in the company after six months, you’re more likely to stick it out for that long, see how it goes, and then invest in the company. Without the option, if you don’t love the position, you may bail faster since you have nothing to lose but your compensation, which is replaceable.
How Stock Options Work
Keep in mind, stock options are the ‘right’ to buy stocks on a specific date. This is the vesting period. You must satisfy the vesting period before exercising your right to buy the stock unless the company allows for early vesting.
You can buy the stocks once the vesting period occurs, but you don’t HAVE to. Any time after the vesting period and within the expiration period, you can buy the stocks or let the stock option expire.
If the stock prices increase higher than your stock option, you can buy the stock at a lower price and earn an instant profit.
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What are RSUs?
RSUs, or Restricted Stock Units, are restricted stock shares that you can’t collect until you meet specific requirements. The requirements are typically the same or similar to those of stock options. You aren’t vested until you meet specific time or performance requirements.
RSUs are like a cash bonus but in the form of stocks. If you receive Restricted Stock Units, you’ll receive them in predetermined increments as outlined in your offer. The value of the RSU on the day you become vested is what you’ll pay taxes on, although RSUs are taxed as ordinary income as if you received a cash bonus.
How RSUs Work
Like stock options, RSUs motivate employees to help the company perform. Because you only receive your units once you’ve been with the company for a certain amount of time or once the company achieves a specific goal, it helps with employee longevity and motivation to help the company's success.
Once you achieve the vesting period or the company achieves a specific goal, you receive your units and can do with them as you please. You’ll instantly oweand start paying taxes at your ordinary tax rate as soon as you are vested, and some RSUs will be withheld to cover your tax liabilities.
Comparing Stock Options vs RSUs
The most significant difference between stock options vs RSUs is their tax treatment.
Stock options don’t incur a tax liability until you exercise the option. This means you could be eligible for the stock option and hold it but not exercise it, and you won’t owe any taxes. In addition, if you hold onto the stock options for over a year, you can take advantage of long-term capital gains tax rates, which are much lower than ordinary tax rates.
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Stock options also aren’t always valuable. For example, if the company’s stock price fell below the stock option price, the options are worthless. But, if the stock price increases higher than the option price, you instantly have a capital gain.
Unlike stock options, RSU prices aren’t contingent on the stock’s current price. You earn your units when you fulfill the requirements and own the stock. You don’t have to buy the stock at the option price or wait for it to increase.
Is Equity Compensation Good?
Should you consider equity compensation or hold out for cash compensation only?
It’s a common debate among those changing jobs or looking for a new job. Of course, equity compensation has its benefits, especially if the stock price takes off, which is common for newly public companies. But what happens if the company stock price falls?
You’d stand to lose a lot of money, whereas cash incentives don’t lose their value no matter how the company does.
Receiving equity compensation such as incentive stock options or RSUs is like getting the best of both worlds. You have your salary and an investment in the company. What you do with the investment is up to you, but it gives you a piece of ownership in a company that can give you more reason to want to do well at your job.