What Is the Difference Between RSUs and Stock Options?

Equity compensation forms a significant part of employee benefits in various industries, especially within technology and startups. Companies often use these incentives to attract, retain, and motivate talent. Among the prevalent forms of equity compensation are Restricted Stock Units (RSUs) and Employee Stock Options. These compensation structures align employee interests with the company’s long-term success.

Restricted Stock Units (RSUs)

A Restricted Stock Unit (RSU) represents a promise from an employer to deliver shares of company stock to an employee once certain conditions are met. These conditions involve a vesting schedule, which can be time-based (e.g., over several years) or performance-based, tied to specific company or individual achievements. A common time-based vesting schedule might release a percentage of the granted RSUs annually over a four-year period.

Once the vesting conditions are satisfied, the RSUs convert into actual company shares, which are then delivered to the employee. RSUs hold inherent value from the moment they are granted because they represent actual shares to be received in the future, meaning they will always have some value as long as the company’s stock price is above zero.

The value of an RSU directly corresponds to the market value of the company’s stock at the time of vesting. Employees do not pay to acquire RSUs; instead, they receive the shares upon vesting without an upfront purchase. This characteristic distinguishes them from other forms of equity compensation that might require an investment from the employee.

Employee Stock Options

An Employee Stock Option grants an employee the right, but not the obligation, to purchase a specified number of company shares at a predetermined price, known as the “strike price” or “exercise price,” within a certain timeframe. Options have a “grant date” (when awarded), a “vesting period” (when exercisable), and an “expiration date” (the last day they can be exercised).

The process of “exercising” an option means buying the shares at the strike price, which is typically set at the stock’s market value on the grant date. Employees can only exercise options that have vested, meaning they have met the conditions, often time-based, set by the company. Once exercised, the employee becomes a shareholder and can then hold or sell the acquired shares.

Stock options only provide financial benefit if the company’s stock price rises above the strike price, making them “in-the-money.” If the stock price falls below the strike price, the options are considered “underwater” and may become worthless, as purchasing shares at the higher strike price would result in an immediate loss.

Comparing RSUs and Stock Options

The fundamental nature of these equity compensation types differs significantly. RSUs represent a promise of actual shares that will be delivered upon vesting, essentially a deferred stock grant. In contrast, stock options provide the recipient with the right to buy shares at a fixed price, requiring a separate action to acquire the stock.

Regarding value at grant, RSUs typically possess inherent value from the outset, as they are tied to real shares. Stock options, conversely, derive their value from the potential for the stock price to appreciate above the specified exercise price.

There is also a difference in cost to the employee. RSUs generally do not require any upfront capital; the shares are received upon vesting. Stock options, however, necessitate an investment from the employee to “exercise” them.

RSUs do not involve an exercise step; shares are automatically delivered once vesting conditions are met. Stock options, on the other hand, require an active decision and transaction from the employee to exercise the right to purchase shares. This exercise requirement adds a layer of complexity and a financial outlay for the employee.

Considering downside risk, RSUs maintain some value even if the stock price declines, unless the company faces bankruptcy, making them a more stable form of compensation. Stock options carry a greater risk; they can become entirely worthless if the market price of the stock falls below the exercise price.

Tax Considerations for Both

The tax treatment for RSUs generally occurs at the time of vesting. The fair market value of the shares received on the vesting date is typically taxed as ordinary income. This amount is subject to federal income tax, as well as Social Security and Medicare taxes, similar to how regular wages are taxed.

For Non-Qualified Stock Options (NQSOs), the primary tax event occurs when the options are exercised. The difference between the fair market value of the stock on the exercise date and the lower exercise price is taxed as ordinary income. This income is also subject to federal income tax, Social Security, and Medicare taxes. Tax rules related to equity compensation can be complex and are influenced by individual financial situations; therefore, seeking professional tax advice is often recommended.