A Guide to Restricted Stock Vesting and Employee Compensation

Restricted stock vesting is a way for companies to tie employee compensation to their performance and retention. This means that employees must meet certain conditions, such as staying with the company for a set period, before they can fully own the stock.

The vesting period can range from one to five years, depending on the company's policies. For example, a company might have a vesting period of three years, where 25% of the stock vests annually.

Employees must be aware of the vesting requirements to avoid forfeiting their stock. If they leave the company before meeting the vesting requirements, they may lose some or all of the stock.

Restricted stock units, or RSUs, are a type of equity compensation that grants employees a specific number of company shares. These shares are subject to a vesting schedule, which dictates when ownership rights are activated.

RSUs are essentially a promise of future shares, but the recipient can't actually collect them until the vesting requirements are met. This means employees need to satisfy specific conditions before they can receive the shares.

RSUs are often used as an incentive to attract and retain top talent. Companies like to offer RSUs because they can motivate employees to stay with the company for the long term, and if the company performs well, the employee can receive a significant financial benefit.

There are three main types of RSUs: Time-Based, Performance-Based, and Event-Based. Time-Based RSUs require employees to reach specific date milestones, such as remaining employed by the issuer until a certain date. Performance-Based RSUs require employees to satisfy performance-based targets, such as KPIs tracking individual productivity. Event-Based RSUs are contingent on certain events, like an initial public offering (IPO).

Here's a breakdown of the three types of RSUs:

If an employee fails to meet the vesting requirements, they won't receive the shares. This is why employees need to understand the contractual clauses stated in their award and the risks of not receiving the compensation.

RSUs can be offered with different restrictions, making them more or less valuable to employees. Some RSUs are subject to only a vesting schedule, known as single-trigger RSUs.

Single-trigger RSUs are the most common type, where the vesting schedule is the only condition that must be fulfilled. They're often referred to as single-trigger because there's only one trigger for vesting, which is the time-based vesting schedule.

Double-trigger RSUs, on the other hand, include additional conditions that must be fulfilled along with vesting. This means that even if the employee meets the vesting schedule, they still won't receive the RSUs if they don't meet the additional conditions.

Here's a breakdown of the different types of RSUs:

In practice, single-trigger RSUs are often used because they're simpler to administer and understand. However, double-trigger RSUs can provide more flexibility and control for employers.

RSUs are a type of equity compensation that grants employees a specific number of company shares subject to a vesting schedule and potentially other stipulations. The vesting schedule dictates when ownership rights are activated, typically upon completing a certain number of service years.

Companies use RSUs as an incentive to attract and retain talent, and they can be appealing because if the company performs well and the share price takes off, employees can receive a significant financial benefit.

RSUs are "restricted" because the distribution of the shares to the recipient is subject to a vesting schedule. This means that employees granted RSUs must understand the contractual clauses stated in their award and the risks of not receiving the compensation.

There are three types of RSUs: Time-Based, Performance-Based, and Event-Based. Time-Based RSUs require the employee to reach specific date milestones, such as remaining employed by the issuer until a certain date. In a graded vesting schedule, the RSUs vest by a set percentage each year, whereas in a cliff vesting schedule, the RSUs vest entirely at once in a specified year.

Performance-Based RSUs require the employee to satisfy performance-based targets, which most often consist of KPIs tracking individual productivity. Event-Based RSUs could be contingent on certain events, such as the issuer undergoing a liquidity event like an initial public offering (IPO).

Here's a breakdown of the vesting schedule for RSUs:

Until the conditional provisions for the RSUs to vest are satisfied, the recipient is unable to actually collect the shares. This means that employees granted RSUs must fulfill their obligations and abide by the terms set under the employment agreement to receive the shares.

The taxation of RSUs is usually more straightforward than restricted stock, as it doesn't involve the 83(b) election.

Only the vesting date matters for tax purposes, which means the fair market value of the stock on that date determines the income tax treatment.

Companies often withhold some shares to cover the tax burden when the RSU vests, a strategy known as the "sell-to-cover" approach.

This results in the RSU holder receiving fewer shares than they would have otherwise.

The RSU recipient may also be required to pay capital gains tax when the shares are eventually sold.

There are no tax consequences on the grant date, as no shares are technically distributed yet.

However, once the shares vest and all conditions are met, the distribution of the shares triggers a tax liability.

The taxable income is calculated based on the fair market value of the shares at vesting, which is treated as employee compensation and deemed to be taxable income.

RSUs are subject to federal and employment tax, as well as state and local tax, although the specifics can vary by jurisdiction and the terms of the RSUs agreement.

In some cases, companies may offer to offset the tax liability by reducing the shares received by the amount of tax owed.

RSUs offer a simpler understanding of equity compensation compared to other forms, with a clear vesting schedule and straightforward calculation of award value.

One of the biggest advantages of RSUs is that they retain value, even if the share price drops. This means you can still sell vested shares and make a profit, unlike stock options that might expire worthless.

Selling vested shares also provides flexibility, allowing you to use the cash for other priorities like retirement accounts, paying off debt, or funding a child's education.

However, tax consequences can be a significant drawback, especially for employees with private companies. You might face a hefty tax burden when all your shares vest at once, and even assistance from your employer might not completely offset the actual tax owed.

Uncertainty about the future can also be a concern, particularly with private companies where you'll have to wait before selling and receiving any reward for fronting those taxes.

RSU grants can be tricky to account for, but essentially, the company records a debit to a contra-equity account for the fair value of the stock at the grant date.

If the company doesn't allow the presentation of a contra-equity account, they'll only show the vested portion of the common stock and APIC, which would be 25% of the grant in this example.

At the grant date, a journal entry would be made to credit common stock and APIC for the fair value of the stock, in this case $100,000.

RSU grants can be quite technical to account for, but essentially, the value of the shares is determined on the grant date, and the compensation expense is recognized over the employee's service period.

The fair value of the stock on the grant date is $100,000, and 25% of the grant vests annually over four years. At the grant date, a journal entry is made debiting a contra-equity account for $100,000 and crediting common stock and APIC for $100,000.

The compensation expense is then recognized over the employee's service period, with the value of the shares being delivered to the employee.

Companies can offer their own securities as part of written compensation agreements to employees, directors, general partners, trustees, officers, or certain consultants without having to comply with federal securities registration requirements. This is made possible under Rule 701 of the Securities Act of 1933.

The total sales of stock during a twelve-month period must not exceed the greater of $1 million, 15% of the issuer's total assets, or 15% of all the outstanding securities of that class. This is a key requirement for exemption from registration.

To qualify for this exemption, the offerings must be discrete, not included in any other offer. In other words, they must be stand-alone transactions.

All optionees and shareholders must be provided with a copy of the benefit plan or contract under which the options or securities are granted. This ensures transparency and compliance.

If total sales exceed $10 million during a twelve-month period to the specified class of people, companies must disclose additional information. This includes risk factors, copies of the plans under which the offerings are made, and certain financial statements.

From the employer's perspective, RSUs offer several benefits. They serve as a performance reward, acknowledging the contributions of individual employees, which can be crucial for a company's growth.

RSUs are also a non-cash expense, conserving cash for the company, as no upfront cost is incurred. This makes them particularly appealing to venture-backed startups and high-growth companies that are still unprofitable.

The limited dilution of RSUs is another advantage, as the creation of additional shares is a trade-off for competent, long-term employees. Shareholders often consider this a worthwhile investment, given the potential long-term success of the company.

RSUs can also help with employee retention, making it easier to attract and keep top talent. This can save a company time and money in the long run, as well as boost overall employee morale.

Here are the key benefits of RSUs from the employer's perspective:

As an employer, you have a unique opportunity to motivate and reward your employees with Restricted Stock Units (RSUs). By issuing RSUs, you can acknowledge the contributions of individual employees, conserving cash and reducing dilution of ownership.

RSUs can be a game-changer for employee retention, as they provide a non-cash expense that doesn't require upfront costs. This is especially beneficial for venture-backed startups or high-growth publicly-traded companies that are still unprofitable.

One of the key benefits of RSUs is that they can align the incentives of employees and equity shareholders. Since employees are granted conditional stakes in the company's equity, RSUs can function as a motivator to outperform and contribute to the company's long-term goals.

From an employee's perspective, RSUs can be a more straightforward compensation option compared to stock options. With RSUs, employees are not required to purchase shares at a predetermined price, eliminating the risk of holding onto an out-of-the-money option.

Here are some key differences between RSUs and stock options:

Ultimately, RSUs can be a valuable tool for employers looking to attract and retain top talent while conserving cash and reducing dilution. By understanding the benefits and differences between RSUs and stock options, employers can make informed decisions about their compensation packages.

As a company grows, it's essential to be aware of the rules that govern its securities offerings. Once an issuer exceeds 2000 shareholders, it's generally required to register under the Securities and Exchange Act.

This means full disclosure as a public company, which can be a significant undertaking. The issuer may, however, continue to rely on Rule 701 to sell any securities previously offered.

Securities issued under Rule 701 are restricted securities, which can only be resold through registration or compliance with an applicable exemption. This is a crucial consideration for companies looking to expand their shareholder base.

Transactions exempt from registration under Rule 701 are not exempt from anti-fraud, civil liability, or other provisions of federal securities laws. This means issuers must still provide substantial disclosure of information to securities purchasers.

It's worth noting that the SEC's website has a detailed discussion of Rule 701, which was amended in 1999. However, it's always best to consult securities laws experts before making any decisions.

If actual shares are delivered to the employee, then journal entries impact equity. The value of the shares is paid in cash, then the company would most likely record a liability.

The vesting schedule outlines the date on which the RSUs were awarded and the dates on which the shares vest, assuming the predefined conditions are met. The award amount is also stated, which determines the quantity of share units earned.

Once the conditions established by the vesting schedule are met, the employee receives the shares or a form of compensation with an equivalent value. This typically occurs over a period of time, such as four years, with 25% of the grant vesting annually.

The distribution schedule specifies the form of payment, such as stock-settlement or cash-settlement, and the timeline in which the proceeds would be paid out.

The distribution of RSUs is a crucial aspect of selling and vesting RSUs. The company's upper-level management determines the form of payment, which can be stock-settlement, cash-settlement, or a dividend of equivalent value.

Once the conditions established by the vesting schedule are met, the employee receives the shares or a form of compensation with an equivalent value. This is typically outlined in the distribution schedule, which specifies the timeline in which the proceeds would be paid out.

The distribution schedule can be a bit complex, but essentially it's a plan that outlines when and how the employee will receive their RSUs. For example, if the RSUs are stock-settled, the employee will receive actual shares of the company's stock.

The vesting schedule and distribution schedule are two separate documents that work together to determine when and how the employee will receive their RSUs. Understanding these schedules is key to selling and vesting RSUs successfully.

Here's a breakdown of the key elements of the distribution schedule:

The distribution schedule is an important document that outlines the terms of the RSU award. It's essential to review this document carefully to understand when and how you'll receive your RSUs.

If your employer is a publicly traded entity, you can sell your vested shares at any time, assuming you're okay with the share price.

Selling shares can be a good option if you need cash to pay for taxes or want to diversify your portfolio by reducing your exposure to one company.

Holding on to shares out of company loyalty or because you believe in the company's future prospects is understandable, but it's essential to consider the potential risks of a concentrated stock position.

You may be able to sell shares and produce cash to fund other financial goals, but be aware that selling shares can have tax consequences, including capital gains.

If you sell shares after holding them for over a year, the gain is considered long-term and is generally subject to less tax than a short-term capital gain.

If your employer is a nonpublic entity, selling shares can be more challenging since there's no readily available marketplace.

In this case, you may need to fund taxes out of pocket or wait for a liquidity event, such as an IPO or SPAC listing, which can offer an opportunity to sell shares and cover tax liabilities.

Measuring sales is a crucial aspect of understanding how RSUs work.

The limit for sales is based on actual sales, not just offers.

In measuring sales, all options granted during the period are considered part of the aggregate sales, with the option price defined as of the date of grant.

Repriced options are treated as new grants, so their value is calculated from scratch.

For restricted stock or compensatory stock purchases, calculations are made as of the date of sale.

The date of sale is when the stock is actually sold, not when it's granted or vested.

For deferred compensation equity plans, measurements are based on the date of an irrevocable election to defer compensation.

This means that if you choose to delay receiving your compensation, the measurement date is the date you made that choice.

In calculating outstanding securities for the 15% rules, all currently exercisable or convertible options, warrants, rights, and other securities are treated as outstanding.

This means that if you have options that can be exercised or converted, they're counted towards the 15% limit, even if they haven't been exercised yet.

The rule also requires that if stock is provided in exchange for employee or consultant services, the value for the purposes of the exemption calculations is the price of the stock provided, not the amount of compensation foregone.