What Are The Differences Between Restricted Stock Units (RSUs) and Employee Stock Options (ESOPs)?

LOVE LAW FIRM discusses RSUs and ESOPs for NY small businesses

Start-ups and existing companies in New York may be looking for a perk for employees beyond the basic benefits package. Sharing in the success of the company can be a benefit that’s a win-win for both the business owner and the employees. 

Stock options benefit employees who will gain financially from their receipt, and they also guarantee that employees participating in the program are more personally invested in the success of the business. Personally-invested employees are incentivized to do good work, which can pay off for the employer.

More on Stock Options

Stock options are stocks sold from one party to another without any requirement to buy or sell at a specific time. Typically, it is the business owner who gives an employee stock option to be bought or sold at any time prior to the expiration date without any obligation. An employer may provide stock options as part of an employment agreement. This is in effect, a contract for the employee to buy a certain number of shares at a set price during a time period stated in the employment agreement. 

Stock options are another valuable perk with which a business can attract quality employees, and it allows employees to have a stake in the company’s performance. In the past, stock options were typically only offered to company executives; however, the startup culture has made it a frequent benefit for all employees.

Employee stock options are just one type of stock options, and issuing stock options can be a risk when employees don’t stay with the company for the long term. To address this, restricted stock units or RSUs may be the answer.

RSUs Defined

A restricted stock unit is a type of stock option which, as the name suggested, is restricted or has strings attached. So, rather than giving an employee shares and letting him or her buy and sell their options any time they see fit, an RSU is given with specific limitations. 

Restricted stock units have a vesting plan. This plan typically is tied to certain milestones that must be reached before the funds can be distributed, such as performance goals or years of service. While an RSU provides an employee with an interest in the company’s stock, it has no value until the vesting terms have been satisfied. When this happens, the employee is given the shares (with a percentage retained for income tax). Then, the employee is free to sell the shares whenever he or she wants, unless there are certain restrictions on transfer.

What are the Major Differences Between Stock options and RSUs?

Stock options’ exercise price is set based on the full market value of underlying security, and a primary difference between stock options and restricted stock units is what occurs once the vesting period is over. As far as stock options, when that period ends, the options become common stock, and the employee can either buy or sell that stock. There are two types of stock options: non-qualified stock options (NSOs) and incentive stock options (ISOs). For NSOs, you are taxed on the difference between the market price and the grant price (known as the “spread”), which is taxed as regular income. As a result, it’s subject to income tax and payroll taxes, like Social Security and Medicare. 

Incentive stock options (ISOs) usually remain with employees and are an incentive for them to better performance. Incentive stock options are treated as preferred items for alternative minimum tax.

RSUs have no exercise price. With an RSU, in contrast, the way in which it is settled is pursuant to its terms. Payment can be in stock or cash. This is taxed on vesting and treated as regular income. There is also capital gains ramifications if the stock is held for more than a year.

Which is Better for My Business?

To determine which is better, for your company, speak with an experienced New York small business attorney. In general terms, RSUs provide a protection that doesn’t exist with stock options. If the share prices of your company drop to the point where they’re below the option price, your own options will lose their value, and the investment will be worthless.

However, an RSU retains its value from beginning to end. Only if a company goes out of business, would you lose your investment. This eventuality more unlikely than a business’s stock losing money over the course of the years it requires to be vested.

Takeaway

If you are considering restricted stock units (RSUs) or employee stock options (ESOPs) for your employees—or you have issues concerning your current stock option plan—you should work with an experienced New York small business attorney. 

Francine E. Love is the Founder & Managing Attorney at LOVE LAW FIRM, PLLC which dedicates its practice to serving entrepreneurs, start-ups and small businesses. The opinions expressed are those of the author. This article is for general information purposes and is not intended to be and should not be taken as legal advice. 

Francine E. Love
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Founder and Managing Attorney at Love Law Firm, PLLC which dedicates its practice to New York business law