Restricted Stock Awards (RSAs) and Restricted Stock Units (RSUs) are very different, so don’t be fooled by their deceptively similar names.
RSAs are an issuance of a certain number of shares of the startup’s common stock. These shares are typically subject to vesting, meaning that they cannot be sold or transferred until certain conditions are met, such as the employee remaining with the company for a specific period of time.
RSUs are a promise by the company to issue stock after certain vesting milestones have been achieved.
The form of equity compensation has a significant impact on the employee and the startup, so you should work with counsel to understand what is right for you. If you’re looking for counsel, feel free to reach out to us here.
RSAs vs. RSUs
RSAs and RSUs are confusingly similar, but there are distinct differences between the two as outlined below:
- Stage of Company
- RSAs are better suited for very early stages, where the fair market value (FMV) of the company stock is nominal, typically before the first round of equity financing.
- RSUs are better for later-stage companies with a high FMV.
- RSAs are issued to an employee at the time of the grant, but the company has the right to repurchase them as the employee achieves vesting milestones.
- RSUs are only issued once the vesting milestone has been completed. Although both RSAs and RSUs can have performance-based vesting milestones, they are more common in RSUs.
- 83(b) Election
- RSAs that are vesting require the employee to file an 83(b) election if they are seeking tax efficiency.
- RSUs don’t require an 83(b) election because the shares are issued without restriction once the vesting milestone is achieved.
- RSAs that are unvested upon termination will be repurchased by the company.
- RSUs that are unvested are forfeited back to the company immediately, without the need for the company to repurchase them.
Taxation on RSAs and RSUs
RSAs and RSUs are subject to different tax treatments.
RSAs are taxed based on the value of the shares at the time they are granted, even if the shares have not yet vested. This means that employees may owe taxes on income they haven’t received yet. It’s best to issue RSAs when the value of the shares is low. Furthermore, if the employee exercises their 83(b), RSAs are typically taxed at the capital gains rate.
On the other hand, employees are not taxed on RSUs until the shares actually vest and are delivered. At that point, the employee will be taxed on the fair market value of the shares at the ordinary income rate.
RSAs and RSUs Are Different than Stock Options
Stock options are a type of equity compensation that grants the employee the right, but not the obligation, to purchase shares of the startup’s stock in the future at a specific price, generally the fair market value at the time of issuance. However, the employee does not actually own the shares; they simply have the right to buy them.
On the other hand, both RSAs and RSUs represent actual ownership of stock in the company. As mentioned earlier, employees own vesting RSAs from the grant date, but the company retains the right of repurchase until they vest. RSUs are issued once the vesting milestone is achieved. In both cases, there is no need to purchase shares in the future.
RSAs and RSUs at Acquisition
In the event of a merger or acquisition, the treatment of RSAs and RSUs can vary depending on the specific terms of the deal.
If the acquiring company purchases all outstanding shares of the target company, RSAs and RSUs will usually convert into equity awards of the acquiring company. This means employees will become shareholders in the new combined entity, with their equity awards now tied to the value of the acquiring company’s stock.
On the other hand, if only a portion of the target company’s shares are acquired, it may be more complicated to determine what happens to outstanding equity awards. In some cases, these awards may be cashed out at their fair market value, while in others they may continue to vest according to their original schedule.
It’s important for employees who hold RSAs or RSUs to carefully review their award agreements and seek guidance from human resources or legal professionals to understand how their equity compensation may be impacted by a merger or acquisition. Additionally, startups should consider these potential scenarios when designing their equity compensation plans to ensure they provide fair and transparent benefits for employees even in times of change and uncertainty.
RSAs and RSUs Impact on the Startup’s Cap Table
RSAs and RSUs can have different effects on a company’s cap table, which is a record of all the company’s securities, including stocks, options, warrants and other equity instruments.
With RSAs, the shares are typically issued immediately upon grant but may be subject to restrictions that prevent the shares from being transferred or sold until they vest. This means that the shares will count toward the total number of outstanding shares on the company’s cap table from the time they are granted.
On the other hand, with RSUs, no actual shares are issued until they vest. At that point, the employee receives newly issued shares of stock in exchange for their vested RSUs. Until then, however, RSUs are simply an accounting entry on the company’s books and do not impact the cap table.
It’s important for startups to carefully consider how their choice of equity compensation will impact their cap table over time. For example, if a startup issues too many RSAs early on in its life cycle, it may dilute existing shareholders and make it more difficult to attract new investors in future funding rounds. Similarly, if a startup issues too many RSUs without considering potential future growth or acquisitions, it may find itself short on available shares when it comes time to compensate new hires or retain top talent.
Startups should work closely with legal and financial advisors to design equity compensation plans that balance employee incentives with long-term growth goals and ensure that their cap tables remain healthy and attractive to investors. If you’re looking for legal support on this, feel free to reach out to us here.