Restricted stock units (RSUs) and stock options are both forms of equity compensation granted by companies to employees. If you're a tech employee, it's important for you to understand how the two types of grant differ, as there are potentially consequences for your tax and the total amount of equity compensation you'll earn in the future.
There are a few important differences between stock options and RSUs that we'll discuss. This includes taxation, exercising, vesting and more. Let's get into it.
What is a stock option?
Essentially, a stock option is a contract between an employer and an employee, where the employee earns the right (or 'option') to purchase company stock at a given point in the future. Employees can't turn their stock options into shares all in one go: stock options vest over time, meaning you gradually earn more of your total equity allocation the longer you work with your employer.
Every individual's stock options are part of a company-run employee stock ownership plan (ESOP). Usually, stock options vest over a four-year period: Ledgy's 2023 State of Equity report indicated that 75% of vesting schedules in the UK last for four years, with a 12-month 'cliff' – the vesting period that has to expire before any of your equity vests. That means to earn your entire equity grant as detailed in your employment contract and/or share option agreement, you usually have to work for the company for four years, completing your vesting schedule.
Stock options turn into shares once they are 'exercised'. Exercising takes place when companies open an exercise window, which is an opportunity for optionholders to turn their options into shares. (It is up to companies when they open the exercise window, and for whom the window opens. Many companies aim to do this about once a year.) Once optionholders pay the exercise price – also known as the strike price – they become shareholders.
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What is an RSU?
A restricted stock unit is a unit of company stock which employees earn over time. Like stock options, RSUs vest over time. RSUs do not need to be exercised: once RSUs vest, they automatically turn into shares. Restricted stock awards are granted by companies to their employees to provide an easy way to distribute company ownership and offer team members the chance to financially benefit from their work building the business.
Who uses RSUs?
RSUs are used by lots of different companies at various stages, both private and public. The way RSUs are awarded can be different depending on whether your company is private or public. In particular, look out for whether your RSUs vest with a single trigger or a double trigger.
RSUs need certain conditions in order to vest and turn into shares. These conditions might be performance-based, time-based or event-based. Single-trigger RSUs only need one condition to be met – usually the length of time an employee has spent with the business – before they vest. This type of RSU is usually held by public companies.
As the name implies, double-trigger RSUs need more than one condition to be met before they can vest and become shares. This might mean, for example, that employees have to fulfil a time-based condition and the business also needs to undergo an exit or liquidity event like a merger, an acquisition or an IPO) in order for employees' RSUs to convert to shares.
What are the main differences between share options and RSUs?
Let's run through the main ways stock options and restricted stock units are different.
Exercising and upfront payments
RSUs do not need to be exercised by employees: they automatically turn into shares once they vest. One positive consequence of this for RSU holders is that there is no upfront financial investment required. This is not the case for share options, which demand that employees pay a strike price (usually a discount to the fair market value) in order to turn their options into shares.
Even if the strike price per share is low (such as one penny or cent per share), this can add up to hundreds or even thousands of pounds for employees before they receive a return on their equity. With RSUs, employees can avoid this upfront payment.
What happens after you leave
Usually, employees leaving the company lose their right over any RSUs that are unvested at the point they depart. This is usually the case with stock options too, but in certain cases companies can set up leaver provisions that state employees who resign lose their rights to all stock options, even the portion that's already vested. This kind of employee-unfriendly clause is very rare in the US with RSUs, but is slightly more common in Europe.
There are important differences to bear in mind in how stock options and restricted stock units are dealt with by tax authorities. (Remember that this is only general guidance: taxes vary from jurisdiction to jurisdiction, and you should consult a tax or financial advisor before making complex financial decisions.) Let's
In the UK, RSUs are taxable as and when they vest and are turned into shares – no tax is due when they are granted. At that point, ordinary income tax is due on the difference between the fair market value of the RSUs when they were granted to you, and the value when your RSUs vest and become shares.
Once RSUs have vested, you'll need to pay income tax. Normally, tax is withheld from your payout, so you will receive your net proceeds with no further action required. However, it's important to check this with your employer.
If you choose to hold on to your RSUs after they vest, capital gains tax may be due on the difference between the value of your shares on the vesting date and the date on which the shares are sold.
Stock option taxation
The main difference between the taxation of employee stock options and RSUs is that while someone selling RSUs immediately will only be taxed once, stock options are taxed at exercise and when a liquidity event happens. When you exercise stock options in the UK, for example, you'll need to pay income taxes on the difference between the exercise price and the fair market value of the company shares. Later, when stock options are sold, you'll normally pay capital gains tax of 20% on the gains from your equity.
Stock options vs RSU: which is better for your company?
It's important to consider which types of equity grant are most common in the different markets where you're active. RSUs are still most commonly seen in US companies, and if you're hiring in the US candidates and employees may expect to be granted RSUs. In Europe, meanwhile, RSUs are less common, with companies broadly preferring to use stock options.
Companies need to take their size and stage into account too. For earlier-stage companies, it can be beneficial to grant stock options before moving to an RSU plan later on, as there is less financial disadvantage to holding shares after they vest (unlike RSUs). Because RSUs convert directly into shares once they vest, companies thinking about going public – or companies that are already public, with an established stock price – will provide the most transparent and liquid route to sell shares for RSU owners.
Founders and boards also need to think about the impact on the team of paying high upfront prices to exercise stock options, depending on the strike price per share. It could be attractive to distribute ownership through RSUs as restricted stock units don't mandate an upfront payment from employees, for instance. (Remember: this is not financial advice, and you should consult with accounting and legal professionals before making decisions regarding your equity scheme.)
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