The Advantages of Using Restricted Stock Units (RSUs) to Compensate Employees
When a company awards restricted stock units (RSUs) to employees, they provide a unique form of compensation that aligns employee goals with the company’s objectives and serves as a powerful retention tool. This article will explore the benefits of RSUs, how they work, and why they are favored over traditional forms of employee stock awards.
Understanding Restricted Stock Units (RSUs)
Restricted stock units (RSUs) are a type of performance-based compensation that gives employees a promise of shares in the future. Unlike restricted stock, which is often issued in a form that is subject to restrictions and vesting periods, RSUs are essentially a promise of stock units that grant the recipient the right to receive shares. The key advantage of RSUs is that they are not taxable until the stock units vest and are converted into shares.
Advantages of RSUs Over Restricted Stock
One of the most significant advantages of RSUs over restricted stock is the tax treatment. When employees receive restricted stock, they must recognize ordinary income tax on the value of the stock at the time of grant, even if they cannot sell the shares immediately. In contrast, RSUs are not taxable until the shares are vested and converted into actual stock, providing a more favorable tax treatment for both the employer and the employee.
Another advantage of RSUs is the alignment of employee goals with the company’s objectives. By tying employee compensation to the long-term growth of the company, RSUs can motivate employees to work towards maximizing stock value. This can lead to better overall performance and increased retention rates.
Cost and Tax Benefits
When RSUs vest, the company faces no direct cost of issuing the shares, as the shares are created for free with a pen stroke. The company pays the employer’s Medicare tax (1.45%) and deducts the current price of the shares. This results in a net benefit for the company, reducing their tax burden by approximately 21% of the value of the shares. This works out to a net cost of -19.55%.
In cases where the company is not profitable, the net operating loss can be subtracted from the previous year’s income or carried forward indefinitely. The IRS does not specify the form of compensation—cash, stock, bitcoin, or even barnyard animals—the crucial aspect is that it remains deductible for the payer and taxable for the recipient.
Employee Incentives and Long-Term Benefits
One of the most compelling advantages of RSUs is the potential for increased cash flow in the future. Employees receive more cash if the stock price increases between the grant date and the vesting date, which incentivizes them to focus on improving revenue and reducing costs. For example, if Amazon’s stock price increased from $70 to $300 over a four-year period, an employee who received RSUs would benefit significantly in the long run.
Additionally, RSUs provide a benefit even if the stock price remains flat or decreases. Unlike stock options, where the employee only benefits if the company performs well, RSUs provide value even when the stock price does not appreciate. This makes RSUs a more robust and versatile form of compensation.
RSUs in Pre-IPO Companies
In pre-IPO companies, the issue of restricted stock can be complex, especially when there are concerns about the number of shareholders. For companies with over 500 shareholders of record, there is a need to follow the reporting rules for public companies. RSUs can be a better option because they convert to actual stock upon vesting, which avoids the potential issues related to restricted stock.
Google, for example, chose to go public when it crossed the threshold of 500 shareholders, and RSUs could have been a viable alternative to avoid the public market regulations.
Conclusion
Restricted stock units (RSUs) offer a compelling form of employee compensation that aligns employee and company goals, provides strong retention incentives, and offers favorable tax treatment. While they have some unique characteristics, RSUs represent a valuable tool for companies seeking to attract and retain top talent.