Restricted Stock & Restricted Stock Units (RSUs):
What's the Difference and How/Why They're Used in Startups
|Authored by Bryan Springmeyer
Bryan Springmeyer is a California corporate attorney who represents startup companies.
The information on this page should not be construed as legal advice.
Restricted stock and restricted stock units (RSUs) are different things. "Units," which are used in a variety of different executive compensation instruments, generally represent a measurement of contractual rights to a company's stock. Often, the measurement is 1:1, meaning that each unit is exchanged for one share of stock upon the "settlement" of the units. In the case of RSUs, the amount of units that are earned by the employee vests similar to the common provisions of restricted stock. Employees earn units under the vesting conditions of the agreement, and are contractually entitled to exchange the units for stock or cash or some combination of the two depending upon the terms of the agreement.
Restricted stock, on the other hand, is a grant of stock that has certain vesting conditions, usually related to the passage of time and continued employment. The holder has legal title to the stock, which is subject to the company's contractual right to repurchase if the vesting conditions are not met (i.e., the employee/founder is terminated or leaves the company).
Using One or the Other
When a startup has implemented an employee incentive plan that allows for grants of restricted stock or restricted stock units, the plan administrator may consider a couple of different factors in deciding which instrument to use.
Federal Income Tax - property, including stock in a company, triggers certain tax laws if it is given in exchange for service to a company. This results in income tax on the fair market value of the stock. This is particularly troubling for private company employees, since their ability to liquidate the stock to meet their tax burden is limited.
Restricted stock is optimal when the company has little to no value and the recipient makes an 83(b) election. Otherwise, this instrument may result in huge tax burdens on the employee recipient.
As with other forms of equity-based nonqualified deferred compensation, such as stock options, RSUs allow the recipient to defer recognition of income until the point when they exercise their contractual right to stock, assuming compliance with 409A. In a privately held company, the employee may be in a better position to liquidate their stock to pay their tax burden. Plans may also provide for cash payments, up to and exceeding the tax burden of the recipient, which could alleviate that concern.
Shareholder Treatment - Another consideration for management and the plan administrator is whether they want the recipients to become shareholders in the company. Restricted stock recipients typically have full rights as a shareholder for each of the shares they hold - whether they are vested or not. Since RSUs are not actual stock in the company, but rather a contractual right to such stock, the grant recipient only acquires shareholder status when, and to the extent, that the company settles the right with stock. Shareholder status is significant since shareholders vote on important corporate matters, have legal rights as minority shareholders, and the number of shareholders can impact a company's ability to remain private.