{"id":1363,"date":"2017-01-13T00:00:00","date_gmt":"2017-01-13T00:00:00","guid":{"rendered":"http:\/\/www-staging.carta.com\/sg\/blog\/breaking-down-rsas-and-rsus\/"},"modified":"2021-03-05T06:58:52","modified_gmt":"2021-03-05T06:58:52","slug":"breaking-down-rsas-and-rsus","status":"publish","type":"post","link":"https:\/\/www-staging.carta.com\/sg\/blog\/breaking-down-rsas-and-rsus\/","title":{"rendered":"Overview of RSAs vs. RSUs"},"content":{"rendered":"\r\n

Two of the most common alternatives to stock options are Restricted Stock Awards and Restricted Stock Units. By the end of this post you will have a general understanding of how they work, the key differences between them, and, if you\u2019re a founder<\/a>, how to choose between the two when incentivizing startup employees. For a basic overview of founder equity, check out our founder equity post<\/a>.<\/p>\r\n\r\n\r\n\r\n

This post is divided into 4 sections:<\/p>\r\n\r\n\r\n\r\n

1) What is restricted stock? <\/a><\/p>\r\n\r\n\r\n\r\n

2) Vesting and RSUs and RSAs <\/a><\/p>\r\n\r\n\r\n\r\n\r\n\r\n

3) How termination affects RSUs and RSAs <\/a><\/p>\r\n\r\n\r\n\r\n

4) Taxes and restricted stock<\/a><\/p>\r\n\r\n\r\n\r\n

What is restricted stock?<\/h2>\r\n\r\n\r\n\r\n

Restricted stock is very different from a stock option. A stock option gives you the right to buy a set number of shares at a fixed price, but you don\u2019t own the shares until you buy them. With restricted stock, you own the shares from the day they are issued<\/strong>.<\/p>\r\n\r\n\r\n\r\n

But the stock is \u201crestricted\u201d stock because you still need to earn them. The most common restrictions are time-based and involve a vesting schedule<\/a>, which means you earn them over time. This incentivizes employees to stay with the company. If the employee leaves, the company can repurchase the stock.<\/p>\r\n\r\n\r\n\r\n

There are two main types of restricted stock: Restricted Stock Awards (RSAs) and Restricted Stock Units (RSUs).<\/p>\r\n\r\n\r\n\r\n

What are Restricted Stock Awards (RSAs)?<\/h3>\r\n\r\n\r\n\r\n

We\u2019ll be using Sean as an example of an RSA recipient. Sean is one of the first five employees at a startup. Because the startup doesn\u2019t have a lot of cash to pay for salaries, they offer Sean RSAs as part of his offer.<\/p>\r\n\r\n\r\n\r\n

RSA shares are given to employees on the day they are granted. RSAs are typically issued to early employees before the first round of equity financing, when the FMV of common stock is very low. RSAs provide the individual the right to purchase shares at FMV, at a discount, or at no cost on the grant date.<\/p>\r\n\r\n\r\n\r\n

The employee \u201cowns\u201d the stock associated with the RSA on the grant date, but may still have to purchase them, depending on the nature of the offer. This purchase contingency is why RSAs are considered \u201crestricted.\u201d<\/p>\r\n\r\n\r\n\r\n

What are Restricted Stock Units (RSUs)?<\/h3>\r\n\r\n\r\n\r\n

Gus is our second example employee, and he joins the same company seven years later. The company is now successful and the share price has increased dramatically. In addition to a fair salary, the company gives Gus Restricted Stock Units (RSUs) as part of his offer.<\/p>\r\n\r\n\r\n\r\n

An RSU is common stock that will be delivered at a future date, contingent on vesting and performance conditions. RSU shares are not received until the restrictions lapse.<\/p>\r\n\r\n\r\n\r\n

Unlike RSAs, when shares are \u201cowned\u201d by the employee on the grant date, an RSU is a promise from the company to give an employee shares at a later date.<\/p>\r\n\r\n\r\n\r\n\r\n\r\n

The date you actually receive your RSU shares can be a vesting date, a liquidation event, a specified date in the future, or some combination of these. This future date is established when the RSU is granted. Another key difference from an RSA is that the RSU holder does not pay anything to own the shares (outside of applicable taxes)<\/strong>.<\/p>\r\n\r\n\r\n\r\n

Vesting RSUs and RSAs<\/h2>\r\n\r\n\r\n\r\n

RSA vesting<\/h3>\r\n\r\n\r\n\r\n

Vesting<\/a> means you have to earn your shares over time.<\/p>\r\n\r\n\r\n\r\n

Because you legally own RSA shares when they are granted to you, vesting only impacts whether the company can repurchase your shares if you leave or are terminated. Most companies have vesting schedules in place to prevent individuals from joining a company, receiving their RSA award, and leaving immediately.<\/p>\r\n\r\n\r\n\r\n

RSU vesting<\/h3>\r\n\r\n\r\n\r\n

RSU shares are not issued to the recipient until they vest. When a company grants RSUs, they are promising to issue those shares at a later date based on the vesting schedule.<\/p>\r\n\r\n\r\n\r\n\r\n\r\n

RSUs can have multiple vesting conditions. In our example, Gus\u2019 RSUs have a time-based vesting schedule AND a liquidation condition. The liquidation condition states that \u201cthe company must be acquired or IPO before Gus\u2019 shares will vest.\u201d Gus has to satisfy his time-based vesting schedule AND the liquidation condition before his shares will be issued.<\/p>\r\n\r\n\r\n\r\n

How termination affects RSUs and RSAs<\/h2>\r\n\r\n\r\n\r\n

We\u2019ll use Sean (whose compensation includes RSAs) and Gus (whose compensation includes RSUs) to explain how termination differs between RSAs and RSUs.<\/p>\r\n\r\n\r\n\r\n

\"\"<\/figure>\r\n\r\n\r\n\r\n

The chart above shows what happens to Sean and Gus\u2019s shares if they leave the company \u2013 in this example, both Sean and Gus are partially vested upon termination.<\/p>\r\n\r\n\r\n\r\n

Termination and RSAs<\/h3>\r\n\r\n\r\n\r\n

Sean keeps all of his vested shares. His unvested shares, however, are subject to a company repurchase. That means the company can buy the shares back from Sean. Companies will usually repurchase shares at the same price Sean paid for them. It is important to note that the company has the right, but not the obligation, to repurchase the shares from the employee.<\/p>\r\n\r\n\r\n\r\n

Termination and RSUs<\/h3>\r\n\r\n\r\n\r\n\r\n\r\n

Gus also keeps his vested shares, but there is one caveat: because RSUs are often subject to additional vesting conditions (like a liquidation event), it is possible that Gus\u2019 time-vested shares will expire before both conditions are met. If Gus\u2019 shares expire before the company gets acquired or IPOs, he will not get to keep the time-vested shares. Regardless of liquidation conditions, any shares that are not time-vested are forfeited at termination<\/strong>. (Some companies will allow ex-employees to keep RSUs which have met the time-based vesting requirement but not the event-based vesting requirement. It is important to read the grant agreement to understand what will happen to your RSUs in the event you leave the company.)<\/p>\r\n\r\n\r\n\r\n

Taxes and restricted stock<\/h3>\r\n\r\n\r\n\r\n

There are two types of tax to consider with equity compensation: ordinary income tax and capital gains tax. The main thing to remember is that the capital gains tax rate is generally lower than the ordinary income tax rate.<\/p>\r\n\r\n\r\n\r\n

The tax treatment of RSAs and RSUs is complicated and confusing \u2013 knowing how taxation works with these forms of equity compensation can potentially help startup employees save thousands of dollars.<\/p>\r\n\r\n\r\n\r\n

Remember, any time your company pays you \u2014 whether in salary, benefits, or equity \u2014 you owe taxes on that income.<\/p>\r\n\r\n\r\n\r\n

RSA taxation<\/h3>\r\n\r\n\r\n\r\n

When Sean was granted RSAs by his company, he had to pay for his RSA shares to own them outright. Because Sean paid for them on the vest date, his company is not giving him any additional value. This means he doesn\u2019t have to pay taxes on his RSAs when they vest.<\/p>\r\n\r\n\r\n\r\n

Eventually those shares may increase in value. If they do, Sean will have to pay taxes on the gain. It\u2019s easier to see and understand the RSA tax treatment in a graph:<\/p>\r\n\r\n\r\n\r\n

\"RSA<\/figure>\r\n\r\n\r\n\r\n

The graph shows Sean\u2019s RSA taxable gain over time. On the x-axis is the Fair Market Value (FMV) of Sean\u2019s shares. The y-axis (Taxable Gain) is just the current FMV minus the FMV on the grant date ($1). When Sean\u2019s shares vest, the FMV is $5, yielding a taxable gain of $4 ($5-$1).<\/p>\r\n\r\n\r\n\r\n

Any taxable gain between the grant date and vesting is subject to ordinary income tax. Once the shares vest, Sean owns them. At this point, any subsequent gain between vesting and sale is subject to capital gains tax.<\/p>\r\n\r\n\r\n\r\n

The key takeaway here is that you\u2019re paying tax when shares vest. At this point, however, the shares may be illiquid (which means you can\u2019t sell them). The yellow line in the graph could just as well plummet after vesting, and the shares would be worthless. If you\u2019ve already paid tax, the IRS will not refund your payment.<\/p>\r\n\r\n\r\n\r\n

Thankfully, there\u2019s a solution for this.<\/p>\r\n\r\n\r\n\r\n

Section 83(b) election<\/h3>\r\n\r\n\r\n\r\n

The 83(b) election means that you can choose to pay all of your ordinary income tax up front. A valid question now would be, \u201cwhy would I want to pay taxes early?\u201d<\/p>\r\n\r\n\r\n\r\n

As you\u2019ll see in the next graph, the taxable gain is usually zero (or close to zero) when you make an 83(b) election. Because you haven\u2019t \u201cgained\u201d anything yet you don\u2019t have to pay ordinary income tax on your RSA holdings. It\u2019s important to note that there is a 30-day deadline from the grant date to file an 83(b) election. After this window passes Sean will not be able to file the election.<\/p>\r\n\r\n\r\n\r\n

\"\"<\/figure>\r\n\r\n\r\n\r\n

Sean\u2019s taxable gain is zero at grant because the FMV is the same as what he paid ($1). By filing an 83(b) election, Sean is choosing to recognize ordinary income tax up front. Since the taxable gain is $0, Sean pays no ordinary income tax.<\/p>\r\n\r\n\r\n\r\n

Even when the RSA shares vest, Sean pays no tax. Instead, he pays a capital gains tax on the full $9 gain when he sells the shares. This is favorable for two reasons:<\/p>\r\n\r\n\r\n\r\n

1) the capital gains tax is a lower rate than the ordinary income tax<\/p>\r\n\r\n\r\n\r\n

2) he does not run the risk of paying taxes on illiquid shares that cannot be sold<\/p>\r\n\r\n\r\n\r\n

RSU taxation<\/h3>\r\n\r\n\r\n\r\n

The main thing to know about RSUs and taxes is that you pay ordinary income tax when your shares vest. This is similar to how RSAs are taxed if you don\u2019t make the Section 83(b) election.<\/p>\r\n\r\n\r\n\r\n

The following graph is the same as the RSA graph from above without the section 83(b) election.<\/p>\r\n\r\n\r\n\r\n

\"\"<\/figure>\r\n\r\n\r\n\r\n

Gus’ RSU was granted when the FMV was $10. Since he doesn\u2019t receive any shares when the RSU is granted, he is not responsible for paying taxes on that $10. The taxable gain is $0 on the grant date.<\/p>\r\n\r\n\r\n\r\n

Instead, Gus will pay ordinary income tax on the full FMV when his RSUs vest at the FMV of $15. But why is Gus responsible for taxes on the full $15 when Sean only paid taxes on the $4 gain for his RSA? It\u2019s because Sean paid the $1 to purchase his shares when he was granted his RSA.<\/p>\r\n\r\n\r\n\r\n

Like the gain on Sean\u2019s RSA, Gus will pay capital gains tax on the difference between the $15 FMV at vesting and the $18 FMV when he sells.<\/p>\r\n\r\n\r\n\r\n

Remember that RSUs often have multiple vesting conditions; in the example above, we assumed Gus\u2019 RSU only had time-based vesting. Now, let\u2019s look at how a liquidation condition affects his RSU taxes:<\/p>\r\n\r\n\r\n\r\n

\"\"<\/figure>\r\n\r\n\r\n\r\n

Gus decides to sell his RSU at the same time it vests. He will be taxed when the time-based vesting AND liquidation requirements are satisfied. He’ll pay ordinary income tax on the entire value of his RSU ($18) when he sells.<\/p>\r\n\r\n\r\n\r\n

Recap: RSAs vs. RSUs<\/h2>\r\n\r\n\r\n\r\n
\"\"<\/figure>\r\n\r\n\r\n\r\n

The chart above outlines the key differences between Restricted Stock Awards and Restricted Stock Units. To recap:<\/p>\r\n\r\n\r\n\r\n