Your source for data-driven advice on investing and personal finance. See how Wealthfront can help you reach your financial goals. One of the biggest changes in the structure of Silicon Valley private company compensation over the past five years has been the increasing use of Restricted Stock Units RSUs. That all changed in when Microsoft invested in Facebook. To understand why RSUs emerged as a popular form of compensation, we need to look at how RSUs and stock options differ.
RSUs or Options Which is better for the employee?
More than 40 years ago a very intelligent attorney in Silicon Valley designed a capital structure for startups that helped facilitate the high-tech boom. His intention was to build a system that was attractive for Venture Capitalists and provided employees a significant incentive to grow the value of their companies.
Stock Options, Restricted Stock, Phantom Stock, Stock Appreciation Rights (SARs), and Employee Stock Purchase Plans (ESPPs)
Issuing stock options with exercise prices below the fair market value of the Common Stock would result in the recipient having to pay a tax on the amount by which the market value exceeds the cost to exercise.
Appraisals are pursued approximately every six months to avoid employers running the risk of incurring this tax. This system continues to provide an attractive incentive to employees in all but one case — when a company raises money at a valuation well in excess of what most people would consider fair.
Let me explain why. In Facebook decided to engage a corporate partner to accelerate its advertising sales while it built its own sales team. At the time Microsoft was falling desperately behind Google in the race for search engine advertising.
It wanted the ability to bundle its search ads with Facebook ads to give it a competitive advantage vs. Microsoft then did a very savvy thing to win the Facebook deal. The extremely high valuation created a recruiting nightmare for Facebook. RSUs or Restricted Stock Units are shares of Common Stock subject to vesting and, often, other restrictions.
Prior to Facebook, RSUs were almost exclusively used for public company employees.
Let me provide a private company example to illustrate. The final major difference between RSUs and stock options is the way they are taxed. The bottom line is RSUs are taxed as soon as they become vested and liquid. In most cases your employer will withhold some of your RSUs as payment for taxes owed at the time of vesting.
In some cases you may be given the option to pay the taxes due with cash on hand so you retain all vested RSUs. As we explained in the aforementioned blog post, holding on to your RSUs is equivalent to making the decision to buy more of your company stock at the current price.
If you exercise your options after they increase in value, but before you are liquid, then you are likely to owe an Alternative Minimum Tax. We highly recommend you consult with a tax advisor before making this decision. Most people do not exercise their options until their employer has gone public. At that point it is possible to exercise and sell at least enough shares to cover the ordinary income tax owed on the appreciation of the options. The good news is, unlike RSUs, you can defer the exercise of your options to a point in time when your tax rate is relatively low.
For example you might wait until you buy a house and are able to deduct most of your mortgage payment and real estate taxes. RSUs and stock options were designed for very different purposes. We strongly believe that with a better understanding of how their use has evolved you will be able to make better decisions on what constitutes a fair offer and when to sell.
We are also very aware of how complex and specific your own decision-making can be so please feel free to follow up with questions in our comment section —they are likely to prove helpful to others as well. Nothing in this blog should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This blog is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome.
Graphs and other images are provided for illustrative purposes only. Our financial planning services were designed to aid our clients in preparing for their financial futures and allows them to personalize their assumptions for their portfolios.
Investment advisory services are only provided to investors who become Wealthfront clients. Many young executives worry about triggering taxes by exercising options. But, as Kent Williams, founding…. Vanguard versus Wealthfront — how do the two compare? In this post, we compare the two services and explain the relative advantages of Wealthfront. Path helps you prepare for your financial future, every step of the way.
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Wealthfront Knowledge Center Your source for data-driven advice on investing and personal finance. Disclosure Nothing in this blog should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security.
Tags career advice , career planning , employee compensation , RSUs , selling plan , stock options. View all posts by Andy Rachleff Questions?
Restricted Stock Is Better Than Stock Options
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