Both RSU and stock options are two similar types of equity compensation, but they have a few key differences. So, what are the differences between RSUs vs stock options? Which one should you choose?
In this article, we will do a complete detailed analysis of RSUs and stock options and what are their advantages and disadvantages.
What are stock options?
A stock option gives you the right, but not the obligation to buy equity in a company, for a certain price (strike price) and during a certain time period, until it reaches the final date.
Stock options have been one of the most common forms of equity compensation, that allow workers to invest in the company they work for. Most stock options have attractive prices, and that means that when exercised, you end up getting shares for a price lower than the current market value.
Stock options limitations
There are usually some limitations when it comes to stock options. There is usually a vesting period, in which you cannot exercise the option. The vesting period can last a few years, depending on how the company structures it.
You will also be limited to exercising a fixed number of shares every year, which is to prevent someone recently joining a company from exercising their options and eventually quitting.
A vesting period ensures that stock options are an equity compensation, designed to motivate employees who help the company achieve its goals. You will be limited to exercising a certain number of shares each year, and you also have to exercise the stock options before the expiration.
Stock options taxes
Stock options are not taxed until you decide to exercise the stock options or sell the shares. There are two types of stock options, and they are taxed differently:
- Incentive Stock Options (ISO)
- Non-statutory Stock Options (NSOs)
Incentive Stock Options (ISO)
With Incentive Stock Options you will not be taxed when you exercise the options. However, gains on the price appreciation will be taxed, as capital gains. It will be taxed as long-term capital gains if you hold the shares 2 years after you were granted the shares. Also, you will need at least to hold the stock for at least 1 year after you have exercised the stock option.
An example of this would be if you are granted 1,000 shares at $10 per share. The stock price appreciates to $100 per share. You decide to exercise your options and buy the 1,000 shares for $10,000. You will not be taxed when you exercise the options. However, when you sell the 1,000 shares for $100,000, you will be taxed as long-term capital gains.
Non-statutory Stock Options (NSOs)
With Non-statutory Stock Options you will either be taxed as regular income, with the amount being the difference between the exercised price and the market price on the date when the stock option was exercised.
For example, if the stock was trading at $10 when it was granted, and the strike price is $5. After 4 years, when the stock is trading at $20, you decide to exercise the options. The amount taxed as income will be $15 ($20 market price - $5 strike price).
What are restricted stock units?
Restricted Stock Units (RSUs) or letter stock are another type of equity compensation that does not require the employee to exercise the options. The company simply commits to giving the employee a certain number of shares in a certain time frame.
RSUs might even be paid in cash or in shares, which becomes attractive for employees that want to receive their equity compensation without holding shares of the company.
RSUs can either be received when the employee stays during a certain period of time with the company or if some performance goals are achieved. RSUs can either be received as shares or as cash payments. For example, a company can award an employee with 100 RSUs that will be vested in 4 years.
Types of RSU
There are two basic types of restricted stock:
- Restricted Stock Awards (RSAs)
- Restricted Stock Units (RSUs)
RSAs: Restricted Stock Awards
With Restricted Stock Awards, the employee is actually given shares of stock. The shares are usually restricted and cannot be sold until a certain period of time has passed or until certain conditions have been met. For example, a company may have conditions that the employee must stay with the company for 5 years or until the company goes public.
RSUs: Restricted Stock Units
With Restricted Stock Units, the employee is not given any actual shares of stock. Instead, the employee is given a contract that entitles him or her to receive shares of stock in the future. The number of shares is determined by the stock price at the time when the RSUs vest.
For example, if an employee is given 100 RSUs and the stock price is $10 per share when the RSUs vest, then the employee would receive 100 shares of stock worth $1,000. This would be subject to income tax when the RSUs are vested.
What's the difference between RSAs and RSUs?
The main difference between RSAs and RSUs is that with RSAs the employee is actually given shares of stock, whereas with RSUs the employee is given a contract that entitles him or her to receive shares of stock in the future. Simply put, an RSA is an actual stock grant, whereas an RSU is a deferred stock grant.
What are the differences between RSUS vs Stock Options?
| RSU | Stock Options | |
| Grant Date | Dated on issuance | Dated on issuance |
| Exercise price | No exercise price | Exercise price based on the market value |
| Vesting | Can be vested anytime for any milestone | Can be vested anytime for any milestone |
| Voting right / Dividends | No, but the company may give a dividend equivalent as a bonus | Upon exercise |
| Tax | Treated as regular income (stock held more than a year treated as capital gains) and taxed upon vesting | NSOs are treated as regular income; ISOs as preferred items for alternative minimum tax |
| Popular for this type of company | Companies that are more mature, later stage | Early-stage, high-growth startups |
| Rationale Common Uses | Taxes are due at the time of vesting, sale of mature stock may support the required payment | Greater potential for an increase in value, employees can time taxation |
What are the advantages and disadvantages of RSUs vs stock options?
RSUs have a few distinct advantages over stock options. But they also have some disadvantages. Here's a closer look at the pros and cons of each.
Advantages of RSUs over stock options:
1. You don't have to pay anything to get the RSUs, unlike options where you have to pay the strike price to exercise the options.
2. The RSUs will be taxed as capital gains, rather than income, as long as you hold the shares for more than a year.
3. With RSUs, there is no risk of the stock price going down and you losing money. With options, if the stock price goes down, you may have to pay money to exercise the options.
Disadvantages of RSUs over stock options:
1. You may not have as much control over when you sell the shares with RSUs. With options, you can choose when to exercise the options and sell the shares.
2. The value of RSUs may not be as high as the potential value of options if the stock price goes up a lot.
3. Options may be a better choice if you think the stock price will go down in the short term but rebound in the long term. With RSUs, you may be stuck with the shares if the stock price falls and takes a long time to recover.
What are the advantages and disadvantages of Stock Options vs RSUs?
Options are more popular than RSUs, however, they can have some advantages and disadvantages compared to RSUs.
Advantages of stock options over RSUs:
1. With options, you have more control over when to sell the shares. You can exercise the options and sell the shares immediately, or you can hold on to the options and wait for the stock price to go up before selling.
2. With stock options, you have the potential to make a lot more money if the stock price goes up than you would with RSUs.
3. If you exercise your options early, you may be able to sell the stock at a higher price than the strike price and still make a profit.
Disadvantages of stock options over RSUs:
1. Options may be a bad choice if you think the stock price will go up in the short term but then drop in the long term.
2. With options, you have the potential to lose money if the stock price goes down.
3. Options may be more expensive than RSUs if the stock price goes up.
4. You may have to pay taxes on the options when you exercise them, whereas with RSUs you may not have to pay taxes until you sell the shares.
Should you choose RSUs or stock options?
It depends on many factors, but there are some key differences between the two that you should know about before making a decision.
As a review, RSUs, or restricted stock units, are company shares that are given to employees as part of their compensation. Units are typically granted at vesting intervals, meaning that employees can't sell or transfer them until a certain amount of time has passed (usually four years). After vesting, RSUs become like any other company stock and can be sold or transferred.
This means that if you are someone that likes to trade stocks frequently, RSUs may not be the best choice for you since you will be locked into them for a period of time.
However, there are some advantages to RSUs that you should consider. For one, they are often seen as more stable than stock options since they don't fluctuate in value as much. Additionally, RSUs typically have fewer restrictions than stock options, meaning that you may have more flexibility with them.
If you do not think you will want to sell or transfer your units right away, RSUs may be a better choice for you. To decide if RSUs or stock options are right for you, it is important to consider your investment goals and risk tolerance.
On the other hand, when it comes to taxes, stock options may have an advantage. With RSUs, you will be taxed on the units when they vest, whereas, with stock options, you can choose when to exercise them. This means that you may be able to time your taxes so that you are in a lower tax bracket when you exercise the options.
Additionally, with stock options, you may have the opportunity to buy shares at a lower price than the current market value. This is called a "strike price." If the stock price goes up, you may be able to sell the shares at a profit. If you are someone that has confidence in their ability to pick stocks, this may be an appealing option for you.
All in all, the decision will come down to your preference for taxation and involvement in the stock market. If you want more control and are willing to pay
taxes on your units right away, RSUs may be the better choice. However, if you want to have the opportunity to buy shares at a lower price and are comfortable with how stock options work, they may be the better investment for you.
Conclusion
Equity compensation can be an exciting proposition. As an employee, it can feel empowering to know that you have the option to own a piece of the company you help grow. However, it is important to understand the implications of each type of equity compensation before making any decisions.
Evaluate your situation carefully and speak with a financial advisor to help you make the best decision for your individual needs. If you have more questions, consider speaking with your employer to understand RSUs and stock options better.
Finally, make sure to bookmark this article so that you can come back and review the key differences between RSUs and stock options later on.