The recent article on Restricted Stock Units from the PayScale blog by Dan Walter provides background for stock plan sponsors on this form of equity compensation. It does a good job of describing the three limitations regarding receiving RSUs, but it stops short of providing any guidance for recipients on what to do with them. In summary, here are the downsides to RSUs that were mentioned in the article:
- The onerous processes required by IRC 409A have resulted in many companies no longer allowing participants to defer the compensation and tax liability
- Participants can’t file an 83(b) election to accelerate income when the taxable value of their shares is low
- Unlike with exercising Stock Options, RSU vestings trigger income and taxation so recipients don't have tax planning flexibility
These issues have a significant effect on dealing with RSUs so here are a few thoughts to help recipients get the most out of this form of equity compensation:
First, when RSUs vest the employee will typically receive the "net" number of shares after the company sells shares to withhold 25% for federal income taxes. Be aware that the withheld amount may not cover the tax liability so it's a good idea to do some tax planning with an advisor to avoid surprises when filing your return.
Next, for planning purposes the net shares after vesting can be added to the other shares that a recipient "owns" outright. To simplify the valuation of owned shares use the estimated cost basis and the long-term capital gains rate (keep in mind that vested RSU shares that have gained value since vesting need to be held for at least 1 year to qualify for the lower long-term capital gains rate). Here's a video that explains owned share valuation concepts.
Owned share valuation and monitoring is important because the holder will need to consider diversification at some point. It's a good idea to do a concentration analysis that compares the value of all company stock and options to the value of one's other investments. Additionally, it is prudent to know the approximate stock price needed for financial goal attainment. To reduce risk consider selling shares when company stock concentration is high and when goal attainment is close at hand. The reduction of a concentrated owned share position will minimize the effects of untimely decreases in company stock price.
Finally, insightful information is the key to effective equity compensation management and company stock plan administration platforms don't generally include information on owned shares, concentration or goal attainment. Talk to your financial advisor and ask them for a Personal Equity Compensation Profile which contains this information. Alternatively, if you like to do-it-yourself you can do so at www.StockOpter.com.
Bill Dillhoefer is vice president at Net Worth Strategies, Inc. a service firm specializing in personalized equity compensation management. Bill led the development effort of a web-based stock plan decision support platform: www.StockOpter.com. This system is used by most of the major financial service firms to assist clients with company stock and options. He is the editor of the StockOpter University Blog which is dedicated to the topic of when to exercise employee stock options and diversify company stock holdings. Bill has spoken at the NASPP conference and to several advisor groups. Connect with him on LinkedIn or follow him @StockOpter.
Equity Compensation – Restricted Stock Units (RSUs), Downside Protection with a Couple Downsides
Dan Walter, Performensation
Last month I covered Restricted Stock Shares (RSS), today’s post covers Restricted Stock Units (RSUs). Where RSS and Stock Options are cousins, RSS and RSUs are siblings. RSS is the older sibling, with more years and experience under its belt. RSUs are the new little sister who came by surprise and often gets more attention than seems to be required. RSUs were seldom used before they shot into the spotlight following the Dotcom crash of 1999-2000. Initially, they were used to replace underwater stock options and slow the use of plan shares approved by shareholders. They provided some protection against a decrease in stock price and used somewhere between 25-50% of the shares require to provide the same value as stock options. They quickly became a major component of the equity compensation toolbox.
RSUs are generally “full value” awards, meaning that they have no purchase or exercise cost to the participant. Unlike RSS, RSUs do not require the issuance of real shares until the units are vested. This is why they are called “units” rather than shares. Many companies use the term “Award” to refer to RSUs, RSS and any other full value instrument. This separates them from the “grant” of appreciation-only instruments like ISOs, NQSOs and SARs. Either term can be used interchangeably. RSUs live in the interesting middle ground between real restricted stock and stock options to purchase shares in the future.
It is also important to note that although the majority of RSUs are designed to settle in stock, these awards can also be designed to allow, or require, settlement in cash. Cash settlement has the upside of not diluting other shareholders’ ownership position and the downside of requiring variable accounting.
As general rule, participants do not have any income from RSUs at the time of award. The ordinary income event occurs when the units vest and shares are delivered. At the time of vest the company is obligated to withhold income and employment taxes for eligible employees.
RSUs fall under IRC 409A, the deferred income and taxation rules. Even private companies need to have a reasonable basis for the value of their stock if they wish to use these awards. It also means that one of the key potential benefits of RSUs, the elective deferral of income, is subject to restrictions that make the process onerous for both participants and companies. Because of this, many companies no longer allow participants to make deferral elections. Another downside: Unlike RSS, participants can’t file an 83(b) election to accelerate income to a time when the spread is very low. Unlike Stock Options, participants do not get to elect when, in the future, the income and tax event takes place. This lack of income and tax planning flexibility is important.
In spite of the downsides, RSUs are a great tool. Because they do not require the immediate issuance of stock, companies can avoid creating instant shareholders and paying ongoing dividends. If the individual leaves with unvested units, the company can easily cancel them rather than go through the process of forfeiture and repurchase. They are an excellent retention tool in companies with an ownership culture and can provide a simple way to provide equity to broad-based participants around the world (we will cover international aspects in a later post).
Like any equity compensation tool RSUs, do not work perfectly as the “only” equity compensation tool for any company. As we explore this equity compensation series the first Thursday of every month we will discuss other tools and way these tools can be used together to provide a complete solution to your company’s needs.
Dan Walter is the President and CEO of Performensation an independent compensation consultant focused on the needs of small and mid-sized public and private companies. Dan’s unique perspective and expertise includes equity compensation, executive compensation, performance-based pay and talent management issues. Dan is a co-author of “The Decision Makers Guide to Equity Compensation”, “If I’d Only Know That”, “GEOnomics 2011” and “Equity Alternatives.”Dan is on the board of the National Center for Employee Ownership, a partner in the ShareComp virtual conferences and the founder of Equity Compensation Experts, a free networking group. Dan is frequently requested as a dynamic and humorous speaker covering compensation and motivation topics. Connect with him on LinkedIn or follow him on Twitter at @Performensation and @SayOnPay.