If you’re a founder or employee at an early-stage startup in the United States, it’s likely you’ve come across the terms “RSAs” and “RSUs.” While they’re often confused due to their similar names, each offers unique features and purposes that are important to understand when evaluating either as equity compensation options.
In this post, we’ll explore the core difference between RSAs and RSUs within the U.S. context, focusing on:
- How each impacts immediate and future ownership for both the company and employees
- The tax consequences of each, including the potential benefits of an 83(b) election for RSAs
- How leveraging RSAs and RSUs attract, retain, and motivate talent at different stages of your company’s growth
Understanding the Basics
Let’s start with the definitions:
Restricted Stock Awards (RSAs) are grants of company shares that are subject to one or more restrictions, with vesting conditions being the most common restriction. If a vesting condition is not met, the company has the right to repurchase or take back the restricted shares.
Restricted Stock Units (RSUs) are promises to issue shares in the future, typically after satisfaction of a vesting condition. If a vesting condition is not met, the RSU is automatically cancelled without the underlying shares being issued.
By far the most commonly used equity compensation tool granted under equity incentive plans is stock options, which are awards that enable employees, advisors and board members to purchase a number of shares of company equity in the future at a fixed price set today. Prior Mantle blogs have addressed stock options in more detail; this article will focus on RSAs and RSUs as alternatives to stock option awards.
Key Differences
Company Stage
RSAs: Early-Stage Startups
Very early-stage startups often opt for RSAs to attract and retain top talent, especially when cash for compensation is scarce. By granting immediate ownership, RSAs can be a powerful incentive for employees to align their interests with the company’s long-term success. However, it’s important to note that this approach can dilute the equity pool more quickly as the shares are immediately outstanding ahead of vesting.
RSUs: Later-Stage Startups
Later-stage startups, with more established business models and potential for growth, may lean toward RSUs. These offer flexibility in rewarding performance and incentivizing long-term commitment. RSUs can also be more tax-efficient for employees, as the tax liability is deferred until vesting for U.S. employees.
Ownership
RSAs: Immediate Ownership
When an employee is granted RSAs, they immediately become shareholders, even before the shares fully vest. This provides them with the voting and economic rights of the shares, giving them a sense of ownership and alignment with the company’s goals.
RSUs: Deferred Ownership
With RSUs, employees don’t own the shares until they vest. This means they don’t have immediate voting rights or the ability to benefit from or sell the shares. However, once an RSU is vested and settled, they receive the shares outright.
Voting & Economic Rights
RSAs: Immediate Voting & Economic Rights
As soon as RSAs are granted, employees gain the same voting rights afforded to other holders of the same class of shares, generally allowing them to participate in shareholder decisions. They also receive the same economic rights that other holders of the same class of shares have, including the right to receive dividends, however unvested RSA shares generally cannot be sold or transferred prior to vesting.
RSUs: Deferred Voting & Economic Rights
With RSUs, employees don’t acquire voting rights attributable to shares until the RSU vests and the underlying shares are issued. Similarly, employees holding RSUs typically don’t have the economic benefits attributable to the underlying shares–they can’t sell or transfer shares subject to unvested RSUs–but some companies implement dividend equivalent rights (DERs) or units (DEUs) to make an employee “whole” for any dividends declared while an RSU is unvested.
Taxation
RSAs: 83(b) Election
The value of RSAs issued to employees is considered ordinary compensation for purposes of U.S. tax regulations. As a result, U.S.-based employees who receive RSAs will generally pay ordinary income tax on the award twice: first, at the time the RSA is granted, on the difference between the value of the shares subject to the RSA at the time of grant and the amount paid for the shares by the employee; and second, at each time the RSA vests, on the difference in the value of the shares on the vesting date and on the grant date. (Employees will also be subject to taxation at the time vested RSA shares are sold, but this time at capital gains rates.) Companies, as employers, are required to withhold taxes from an employee at each taxable event, so granting and vesting RSAs can be a big burden on employers and employees alike, especially if there is no liquidity on recently vested RSA shares. Luckily, taxpayers who have been granted RSAs have the ability to elect to be taxed ahead of vesting by filing an 83(b) election with the IRS within 30 days of the grant date, which can reduce or eliminate the amount of actual tax to be paid over the lifetime of the RSA award. This can be advantageous if the fair market value of the company’s stock is expected to increase over time.
A separate tax advantage of RSAs is that, for U.S.-based employees, the capital gains holding period begins when the shares are issued. Thus, when an RSA is granted, employees can get a head start for long-term capital gains treatment when they sell the shares in the future.
RSUs: Vesting-Based Taxation
Like RSAs, the value of the shares underlying RSUs issued to U.S.-based employees is considered ordinary compensation subject to taxation. However, unlike RSAs, RSUs are only taxed at the time the underlying shares are issued following vesting. Employees will be subject to ordinary income tax on the full fair market value of the issued shares, and their employer will be required to withhold the tax amount, at the time of vesting. The capital gains holding period begins when the vested shares are issued.
Termination
RSAs: Repurchase Rights
If an employee leaves the company before their RSAs fully vest, the company will have the right to repurchase or cancel the unvested shares. Depending on the process described in the RSA agreement, the employing company may need to take action to repurchase or cancel the shares or it may happen automatically.
RSUs: Forfeiture
Unvested RSUs are typically automatically forfeited upon termination, meaning the employee loses the right to receive those shares without further action by the company.
Impact on the Cap Table
RSAs: Immediately Added to the Cap Table
Shares issued pursuant to RSAs are immediately added to the company cap table, even if the shares are subject to vesting. This means RSAs dilute the ownership of existing shareholders.
RSUs: Don’t Immediately Impact the Cap Table
Unlike RSAs, RSUs don’t immediately impact the cap table. They only affect the cap table when they vest and shares are actually issued.
Ultimately, the decision to utilize RSAs or RSUs is a strategic one for any startup founder. RSAs can be a powerful tool in your arsenal for attracting top-tier talent early on, especially when cash flow is tight. That immediate ownership stake can be a game-changer for incentivizing employees and fostering a sense of shared commitment. However, keep in mind the potential for faster equity dilution.
As your company matures and gains traction, RSUs might become a more appealing option. They offer greater flexibility in rewarding performance and aligning long-term incentives. By carefully weighing the distinct characteristics of each, you can create an equity compensation strategy that not only attracts and retains talent, but also sets the stage for your company’s continued growth and success.
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Disclaimer: This blog post is provided as general information to clients and friends of Mantle. It should not be construed as, and does not constitute, financial, legal or tax advice on any specific matter, and employers and employees should always consult their professional advisors, accountants or attorneys as needed when considering decisions or actions that may impact your business or personal interests. Mantle does not assume any liability for reliance on the information in this blog post.