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Restricted Stock Units: The New Currency of the Valley
Published Date : July 8, 2015
The Valley has experienced a dramatic shift over the years from using the competitive value proposition of stock options to attract and retain top talent, to offering restricted stock units as an attractive enticement. This trend started to develop as the incentive models of stock options showed diminishing effectiveness; employees began to realize that a start-up company would have to go public and rise significantly in value for an option strategy to pay in spades. In reality, companies can stay private for a very long time and market volatility can make the difference between hitting the lottery and using your company option agreement as scratch paper. In extreme market volatility, options – at least temporarily – can be worthless if the company’s stock price falls below the exercise price of the options.
According to research conducted by Radford, a leading global provider of compensation intelligence and consulting services to the technology and life sciences sectors, data show the clearest move to Restricted Stock Units (“RSUs”) occurred during the 2008/2009 recession. The stock market downturn during this period essentially wiped out any in-the-money value in option grants for employees. Prior to that, the stock market downturn of 2000–2002 revealed another weak point of options. As a result, over the last 15 years restricted stock units have become the answer to valued incentive plans with some industries in the Valley gaining more traction than others.
A very specific Valley event also helped push the change. In 2007, Facebook realized that its number of stock option holders would soon eclipse the 500-shareholder limit imposed by the SEC. The same issue forced Google to go public in 2004. Restricted stock units don’t count against the shareholder limit. And so the restricted stock unit revolution was born.
Start-up companies often use the restricted stock method because unlike outright compensation, it does not involve the need for immediate access to cash; in effect, RSUs represent fully valued compensation upon vesting. That being said, they are more often found at later stage companies. RSUs are a potentially ideal solution for a company that needs to provide an equity incentive in an environment where the current company valuation is robust but not likely to be monetized through an Initial Public Offering (“IPO”) or acquisition for several years. As a result, they are very common among later stage companies that close venture financing rounds at valuations north of $1 billion (examples include Palantir, Uber, Snapchat, Dropbox, and Pinterest). For these companies, stock options would be worthless to employees until the company had actually attained and exceeded its newly inflated strike price.
A grant of restricted stock units is always worth something, unless the stock price falls to zero. It also makes the employees’ pay dependent on the performance of the company’s stock, giving them extra incentive to improve the company’s performance. This, in turn, has the added benefit of aligning company employees and officers with their shareholders.
For employees and officers with restricted stock units who have never played in this sandbox before, there are some very important wealth and tax considerations at stake. If the restricted stock units make up a disproportionate percentage of your wealth, you’ll want to explore diversification strategies. We understand that you most likely love the company and every way they are changing the world, but markets rule and once vested, an accumulation of restricted stock units with frequent vesting have the potential to change your wealth trajectory. Developing a strategy around diversifying this significant nugget of wealth may be pertinent to your family’s long term financial success.
The tax consequences of equity-based employee compensation are not always straightforward and are sometimes poorly understood. With the increase in personal tax rates over the past two years – especially for California residents – and with wide use of stock options and RSUs, it’s more important than ever to understand the tax impact of these plans.
Employees of pre-IPO companies may face a very real problem of coming up with the resources to pay the required tax withholding that is due immediately upon RSU vesting. Because there’s no public market for the shares, private company employees can’t sell shares to raise cash to pay withheld taxes. At this point, it would be appropriate to engage a secondary market liquidity provider.
Another critical component of tax strategy is the identification of the date the holding period begins for long term versus short term capital gains treatment. As of this writing, the date of vesting is when the holding period begins for gain treatment. However, companies may impose lengthier vesting periods such as in the case where the vesting occurs at either 1) the date determined in the stock agreement or 2) six months after an IPO, whichever is later. The holding period clock starts ticking in this case at the later date. This distinction is critical. If you sell the stock before one year and a day after the determined vesting date, you are subjecting yourself to significantly higher taxes. Both state and federal short term capital gains are taxed as ordinary income. The federal tax can be as high as 39.6% (2015) compared to long term capital gains rates of 20% (www.marketwatch.com).
It can be well worth your time to explore how to apply tax strategies to your own situation, and you should seek the help of your tax accountant and wealth advisor to help guide you in executing them properly. Don’t leave money on the table, or worse yet, paid out in taxes that proper strategy could otherwise potentially minimize.
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Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.
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All video presentations discuss certain investment products and/or securities and are being provided for informational purposes only, and should not be considered, and is not, investment, financial planning, tax or legal advice; nor is it a recommendation to buy or sell any securities. Investing in securities involves varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular client’s financial situation or risk tolerance. Past performance is not a guarantee of future returns. Individual performance results will vary. The opinions expressed in the video reflect Sand Hill Global Advisor’s (“SHGA”) or Brenda Vingiello’s (as applicable) views as of the date of the video. Such views are subject to change at any point without notice. Any comments, opinions, or recommendations made by any host or other guest not affiliated with SHGA in this video do not necessarily reflect the views of SHGA, and non-SHGA persons appearing in this video do not fall under the supervisory purview of SHGA. You should not treat any opinion expressed by SHGA or Ms. Vingiello as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of general opinion. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based solely on any information provided on this video. There is a risk of loss from an investment in securities, including the risk of loss of principal. Neither SHGA nor Ms. Vingiello guarantees any specific outcome or profit. Any forward-looking statements or forecasts contained in the video are based on assumptions and actual results may vary from any such statements or forecasts. SHGA or one of its employees may have a position in the securities discussed and may purchase or sell such securities from time to time. Some of the information in this video has been obtained from third party sources. While SHGA believes such third-party information is reliable, SHGA does not guarantee its accuracy, timeliness or completeness. SHGA encourages you to consult with a professional financial advisor prior to making any investment decision.
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