Sep 4, 2020
Equity compensation is a nuanced and complicated topic. But that doesn’t mean we can’t cover the main points in a single article. In the sections below we’ll break down the different types (RSUs, Stock Options, and ESPP), key definitions, and major considerations.
What are restricted stock units?
Restricted stock units, better known by their abbreviation RSUs, are units that are issued to an employee usually upon employment and/or on a predetermined schedule.
The primary attribute of RSUs is that they require an employee to fulfill a vesting schedule before they transfer from “units” to actual shares of the company stock. When they do, the value of the shares are considered “income” and an employee has the right to sell the stock at their discretion.
That’s right, no strings attached!
What are stock options?
Plot twist, stock options aren’t actually stocks at all. As the name suggests, a stock option gives its holder the right to buy the underlying asset - your company’s stock - at a fixed, and usually discounted price. This is called the grant or exercise price. The benefit here is that if the stock price appreciates, you have the right to buy it at the lower grant price.
Like other types of equity compensation, stock options are usually granted on a vesting schedule. When they vest that means that you are now free and clear to purchase the stock at its grant price.
Types of Stock Options
It’s important to note that there are two different types of stock options: Incentive stock options and non-qualified stock options. Incentive stock options are exclusively granted to employees, while non-qualified stock options are offered to a broader range of people.
Typically, incentive stock options are going to be used by privately held companies, and can only vest up to $100,000 in equity per year. With non-qualified options, there is no limit for vesting.
The most considerable difference between the two is their tax treatment. If exercised correctly, incentive stock options are not taxed as ordinary income until they are sold, while non-qualified stock options are taxed as ordinary income upon exercising the option.
So what’s the catch? Unlike RSUs, you’ll have to use your own money to buy the stock at the grant price.
It’s common for company executives to have a combination of both types of stock options, plus RSUs within their compensation packages. It’s a good idea to work with a financial professional experienced in dealing with equity compensation in order to understand how this compensation may fit into your greater financial plan, and understand your tax implications. If you’re interested in working with an advisor powered by Altruist, find an advisor here.
What’s an employer stock purchase plan?
An Employer Stock Purchase Plan, better recognized by its abbreviation “ESPP” is a company’s internal program that allows an employee to purchase their stock at a discounted price. An ESPP works similar to a 401(K) plan, in the sense that it's a payroll deduction. The plan can be a qualified or non-qualified plan.
What’s the difference between the two?
A qualified plan allows you to purchase stock at a discounted price and delay paying tax on that discount until you exercise your options. A non-qualified plan doesn't offer the same tax benefits, meaning you pay tax on it at the time of purchase.
How does an ESPP work?
There are four phases of the employer stock purchase plan process. The first phase of the plan is called the grant phase. In this phase, the employee is given the option to purchase the stock at a discount up to 15%.
The second phase is called the offering phase, otherwise known as the accumulation period. In this time period, you’ll get to choose a percentage or dollar amount to be used via a payroll deduction to purchase your discounted company stock.
The third phase is called the transfer phase. This is the period after accumulation when the employer takes all of the money that you’ve set aside over the offering period and purchases the stock at the fixed discounted price. After the purchase, the shares will be transferred to you, along with any funds that were not used to buy stock.
The final stage is the disposition phase. The funds are now held in a brokerage account in your name, and you will be free to transfer, sell, or hold them at your discretion.
If you still have unanswered questions about equity compensation, sign up here to connect with a financial professional that can help.
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