Stock Options Vs Restricted Stock Units (RSUs)

By Adel Eisa

December 5, 2024

In addition to free fruit and ping pong tables, one of the key incentives that technology companies offer prospective staff is stock. Depending on the evolution of the company these typically come in the form of stock options or RSUs (Restricted Stock Units). Trying to understand the differences and perceived value can be challenging.

What is a stock option:

Stock options tend to be a good choice for early-stage, high-growth start-ups where stocks are likely to significantly increase in value, particularly as the company scales and also secures future funding rounds. These companies typically do not have revenue and there is a risk, maybe they don’t even have a product. The risks are higher they may never become profitable but in return, if they are successful then the rewards can be much higher.

With stock options, employees are given the right to purchase the stock at a finite time for a predetermined price, like a call option. They will be subject to Capital Gains Tax on disposal but if the option scheme is set up efficiently there is no tax to pay until disposal.

If you are being offered stock options, in your offer letter, there will typically be a reference to a stock option agreement which will detail the type of stock options you get, how many shares you get, your strike price and your vesting schedule.

Your stock option agreement should also specify its expiration date. Vesting means you must earn your employee stock options over time. Companies do this to encourage you to stay with them and contribute to their success. A traditional vesting schedule usually includes a “cliff.” A cliff is the first chunk of shares that vest. In this example, you have a one-year cliff, which is standard, this means after one year you can buy a % of your options.

Without the cliff, you could accept the offer, work for a month, buy a bunch of the company’s stock, and then quit. If your option grant includes a cliff, it prevents that.

The other aspect of your vesting schedule to keep in mind is the total length of the vesting schedule. This outlines how often, and for how long, your shares will vest. Usually, this is over 3 or 4 years.

Typically, if you leave the company, your shares will stop vesting immediately and you can only buy shares that have vested as of that date.

Example of stock option calculations (note this are approx. figures and should only be used as a guide):

100,000 options may sound a lot, but 10,000 options with another company could actually be worth more – it depends on the total shares outstanding.

So, in this example if we assume there are 1,000,000 shares outstanding:

Current value of company is 10,000,000 GBP
You are offered 1000 shares, therefore 0.001% equity, current value -10,000GBP
The share vest 25% each year with no cliff, so at the end of year 1 you would have 250 shares
If we assume the company successfully exited 5 years after you joined at a at a 10x multiplier, then the value of your shares at exit will be 100,000GBP minus the cost to exit (strike price, taxes etc)

What is an RSU:

It’s less common for start-ups to grant RSUs. If they choose this route, they will have to have sufficient cash reserves to fund the taxes. For companies with reliable income streamstreams, RSUs make more sense. Also, when the market value of the common stock is too high to motivate employees to actually buy sstock ooptions, RSUs make more sense.

An RSU is a promise from the employer to provide you with the company’s shares in the future on a certain date. For RSUs you do not have to pay anything, unlike stock options. With RSUs when you receive the shares, you are taxed. The amount to be taxed is dependent on the market value of the shares at the time at which you are awarded. Furthermore, if you decide to sell the shares and make a gain, it would be taxed at the applicable capital gains rate.

So, in contrast to stock options, RSUs will have some intrinsic value and you will effectively always be ‘in the money’.

The difference between Stock Options and RSUs:

One key difference is shareholders’ rights. The employee receives the full shareholders’ rights in the case of stock options. Compared to this, employees do not receive full rights in the case of RSUs. Both dividend rights and voting rights are provided in stock options, but in the case of restricted stock units, dividends are not paid and voting rights are not provided.

Example of RSU calculations (note these are approx. figures and should only be used as a guide):

As an example, suppose Lily receives a job offer. Because the company thinks Lily’s skill set is valuable and hopes she remains a long-term employee, it offers her 1,000 RSUs in addition to a salary and other benefits.

The company’s stock is worth $30 per share, making the RSUs potentially worth an additional $30,000. To give Lily an incentive to stay with the company and receive the 1,000 shares, it puts the RSUs on a five-year vesting schedule

Lily receives 200 shares after one year with the company, another 200 shares after the second year, and so on until she acquires all 1,000 shares at the end of the vesting period. Lily will be free to sell the shares once vested and typically if she left within the 5 years she would lose the unvested shares. Even if the share price falls to $20 she will still be ‘in the money’.

In summary:

Stock options and RSUs are both popular forms of equity compensation and a key driver in the attraction and retention of employees. Evaluation of stock options is more complicated than RSUs, there are lot more factors to consider such as class of stock, potential dilution, good leaver provisions etc and one can write a whole book on the nuances. But what we have seen over the last few years is an expectation from candidates to be offered stock or RSUs and this can be a key factor in whowhom they chose as a future employer.

For any further questions or if you require more information don’t hesitate to get in touch with one of our experienced consultants Adel – Adel.Eisa@ic-resources.com +44 (0)7876 258242