Three Types of Equity Grants: Options, Restricted Stock, and Restricted Stock Units

Startup founders strive to attract and retain talented employees. It’s easy for small businesses and small law firms to burn through funding by only offering monetary compensation. That’s why it may be a good idea to consider equity grants. This way, you not only preserve your cash and extend your runway, but you can also ensure the incentives are aligned and the whole team is collectively working for an “upside”, which is extremely motivating and effective. This article will help you understand the difference among the three most typical equity grants: stock options, restricted stock awards (“RSAs”), and restricted stock units (“RSUs’’).

Stock Options

Company A grants an employee the option to purchase 1,000 shares of Company stock on May 31st at $40 per share (the “strike price”). The employee pays $40,000 to exercise the stock option. However, on May 31st, Company A’s stock is worth $100 per share (the “market price”). As a result, the employee’s shares will be worth $100,000, and if the employee sells his or her shares immediately, the transaction will result in a profit of $60,000.

Vesting

The employee’s stock options are subject to a vesting schedule of 25% over four years. After the first year, the employee may purchase 25% of those shares (here, 250 shares) at the strike price. After four years, the employee’s options are “fully vested,” and the employee may exercise the options on all 1,000 shares.

Tax Considerations

Disadvantages

1) Employees need to pay money to exercise their options.

2) The stock only becomes valuable after the company creates a public market for the stock or company acquisition. If the company fails to go public or get acquired, or if the company does not perform well and its stock price decreases, the options could become a loss or become worthless.

Restricted Stock

Similarly to stock options, restricted stocks are typically subject to a vesting schedule. This incentivizes the employee to remain at the company.

Restricted stock typically takes one of two forms: Restricted Stock Awards (RSAs) and Restricted Stock Units (RSUs). We will discuss the difference between the two below.

Restricted Stock Awards (RSAs):

After the RSAs vest, the employee receives the shares of company stock without further restrictions. The value of RSAs depends on the stock value at vesting. Recipients of RSAs might want to file a section 83(b) election to the IRS, which allows the tax calculation based on the fair market value of the property when it is granted rather than its fair market value on the date that it vests.

Restricted Stock Units (RSUs):

We would like to show you the differences among the three options in the chart below:

After you understand the differences between the three equity incentives, you also need to keep in mind these equities only hold a monetary value if the company is purchased or the company goes public. During these times the stock trades at a calculated value. The value is often calculated by the number of shares available and the valuation of the company. No matter what equity incentive you choose, there is no better way to share your profits via appreciation and encourage retention to your employees.

Are you an employee trying to understand your equity compensation? Are you a startup looking for the best equity incentive plan for new hires? Let us put you in touch with an attorney who can help explain options and restricted stock: https://www.sleegal.com

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