RSUs vs. stock options: Which to choose?

Startup employees face a common dilemma when they’re job hunting and get multiple offers — should they join the startup offering stock options, or the company offering restricted stock units (RSUs)?

It’s rare, but sometimes companies give employees the choice to receive their equity as either stock options, RSUs, or some mix of both.

This article is designed to give you the framework you need to make a better-informed decision between RSUs and stock options.

TL;DR

• Stock options cost money to exercise, while RSUs are earned
• Growth-stage, pre-IPO startups typically offer stock options, while later-stage startups and public companies offer RSUs
• Stock options typically offer greater upside in value, but are more expensive to exercise and carry more risk

What are stock options?

Employee stock options give you the ability to buy a specific number of shares in a company at a specific strike price.

For example, back in 2008, early Facebook employees earned stock options that gave them the ability to buy Facebook stock for as little as 15 cents per share. When the company went public in 2012 at $38 per share, a number of early Facebook employees became millionaires overnight. Today, those same shares are worth more than $200 each.

Many startup employees are given stock options as part of their total compensation package. Stock options come with a vesting schedule, which outlines what the employee must do to unlock the ability to purchase company shares. The most common vesting schedule is time-based — employees need to stay in their job for a specific amount of time before they’re able to begin buying shares.

Once the employee purchases their stock options (also known as “exercising”), they now own shares in the company and can sell them later. If the startup eventually exits — by going public or getting acquired — employees who’ve exercised their stock options are able to sell their shares, ideally at a profit.

In the U.S., stock options are taxed when they’re exercised. Stock option-related taxes can quickly grow into the tens of thousands — and in many cases, hundreds of thousands of dollars — depending on when an employee decides to exercise them.

When it’s time to exercise their stock options, people can be surprised at how expensive they are. That can result in them deciding to forfeit vested stock options when they leave their company, or stay in their job until an exit (also known as golden handcuffs), because they can’t afford their stock option exercise costs.

Stock options are popular with growth-stage startups. There are financial risks associated with exercising stock options — namely, that the startup could fail, and the employee could lose their investment in the company.

What are RSUs?

Restricted stock units, or RSUs, are earned, rather than purchased. They’re more common at late-stage startups preparing to go public, or at companies that have already gone public.

For example, back in 2011, Facebook stopped issuing incentive stock options, and instead began offering employees RSUs. In 2011 alone — one year before the company went public — Facebook issued 55.1 million shares to employees and board members as RSUs.

With RSUs, a company will typically agree to give employees a specific value in the form of shares.

For example, an employee’s stock option grant might specify that they earn $20,000 worth of RSUs each year on Jan. 15. On that date, if the company’s shares were trading for $100 each, the employee would earn 200 shares. One year later, if the shares were trading for $200 each, they’d get 100 shares.

RSUs carry less personal financial risk upon exercise, as employees don’t have to spend their own money to acquire shares. There is likely a more liquid market for the company’s shares, giving employees the ability, in many cases, to turn around and sell their shares for cash.

Because RSUs are typically offered at larger startups and publicly traded companies, they usually experience less upside, but also less risk. RSUs are taxed at exercise, with companies reserving some portion of their value to pay taxes on their employees’ behalf, similar to a cash bonus.

Stock options and RSUs differ in how they’re structured, and how they’re taxed

RSUs and stock options might look similar on the surface, but there are several key differences in how they’re structured, and how they’re taxed.

Let’s first take a look at RSUs. If you’re working for a publicly traded company that issues RSUs, they’re fairly straightforward, with the IRS treating them essentially like a cash bonus. Rather than your company giving you a $50,000 cash bonus (for example), they’re instead giving you $50,000 worth of company stock.

Because RSUs are treated like a cash bonus, they’re taxed as ordinary income when you vest them.

Things are more complicated if you’re working for a privately-held company that issues RSUs. RSUs issued by privately-held companies typically contain what’s known as “double-trigger vesting.” Under double-trigger vesting, two things have to happen before you own your RSUs:

• You have to complete your typical vesting schedule (usually 4 years to fully vest all of your RSUs), and
• The company needs to experience an exit, by either getting acquired by another company, or going public

Until those two things happen, you don’t earn your RSUs. That means you can’t sell your pre-IPO RSUs on a secondary marketplace, because you don’t own your RSUs until both conditions of double-trigger vesting have occurred.

Stock options give you more flexibility. You can exercise them while your company is still private, and you may be able to sell those shares on secondary marketplaces or in company-led tender offers.

Is it better to choose stock options or RSUs?

If you’re facing two competing job offers — one, from a smaller startup offering stock options, and the other from a larger company offering RSUs — you’ll want to step back and ask yourself two fundamental questions: Which company would you rather work for, and what is your risk profile?

Historically, startups are built for hyperspeed. They’re small and they move quickly, gobbling up market share ahead of their larger, slower competitors. Startup stock options represent high risk/high reward.

They can also grow in value very quickly, turning (in the case of Facebook) stock options that were worth 15 cents each into shares that were worth $38 each just four years later.

Larger, publicly traded companies (or startups on the verge of going public) move more slowly, and grow in value more slowly. Still, their value is known, and RSUs can be a lower risk, lower reward option.

In the rare case that you’re being offered a mix of stock options and RSUs at the same company, you’ll want to consider your personal risk profile before choosing the ratio that works for you.

If you ultimately choose stock options, you’ll want to build a plan for how and when you plan to exercise your stock options. For startup employees, there are few things more heartbreaking than wanting to exercise all of your stock options, but finding that you simply can’t afford their cost.

Want to learn more about stock options? Check out Secfi’s Complete Employee Stock Option Starter Guide.