What Are RSUs? A Complete Guide to Restricted Stock Units

What are Restricted Stock Units (RSUs)? 

Restricted Stock Units (RSUs) is a type of equity compensation that allows companies to grant employees shares of company stock at a future date, contingent on meeting certain vesting conditions. These conditions are typically time-based, performance-based or specific company milestones. 

The grant of RSUs itself does not mean ownership of shares. It is only after the vesting conditions are satisfied that RSUs convert into actual company shares. 

Unlike stock options, RSUs do not require employees to pay an exercise price; the shares are delivered automatically upon vesting. RSUs also differ from Restricted Stock Awards (RSAs), where employees receive shares upfront but remain subject to restrictions and the risk of forfeiture if conditions are not met.

How do Restricted Stock Units (RSUs) work?

Let’s walk through an example to understand the lifecycle of RSUs.

1. Grant

At the time of grant, employees are typically awarded a fixed number of RSUs, which convert into actual shares once vesting conditions are met. 

Suppose an employee is granted 1,000 RSUs.

2. Vesting

The RSUs vest based on a schedule outlined in your grant agreement. The most common schedule is time-based. For example, four years with a one-year cliff. That means:

• After 12 months, 25% (250 RSUs) vest
• The remaining 750 vest monthly or quarterly over the next three years

Some companies also offer performance-based or milestone-based vesting, where RSUs only vest if the company hits certain targets, or after events like an IPO.

If you leave the company before all your RSUs vest, you only keep the portion that has vested.

3. Conversion to shares

Once RSUs vest, they convert into actual company shares, and you officially become a shareholder. 

In public companies, you can often sell the shares right away (subject to blackout periods or trading restrictions). 

In private companies, you may have to wait for a liquidity event like an acquisition or IPO before you can cash out.

Depending on your company policy, employees may be given the option to receive cash equivalent to the vested RSUs.

4. RSU taxation

At vesting, the fair market value (FMV) of the shares you receive is considered as ordinary income and thus taxable. For example, if 250 RSUs vest and the share price is $20, that’s $5,000 in taxable income.

To help manage this tax obligation, your company may withhold a portion of the vested shares instead of requiring you to pay out of pocket.

Later, if you sell your shares at a higher price, the gain above the FMV at vesting is treated as capital gains and may be taxed at the capital gains tax rate.

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Why do companies offer RSUs instead of employee stock options or SARs?

Companies choose RSUs over employee stock options and Stock Appreciation Rights (SARs) because they are simpler to administer, easier to account for, and more predictable in value.

Unlike stock options, RSUs do not require companies to set an exercise price, track expiration periods, or handle exercises. They also avoid the structural and payout complexities associated with SARs, which require calculating and delivering only the appreciation in stock value rather than full shares.

For employees, RSUs offer guaranteed value upon vesting, which stock options and SARs do not. 

With stock options, employees must pay to exercise their rights, and if the company’s stock price falls below the exercise price, the options become worthless. SARs provide value only if the stock appreciates beyond the grant price.  

RSUs vs stock options vs SARs

1. Definition

RSUs: A promise to deliver company shares (or their value) in the future, once vesting conditions are met.

Stock options: The right to purchase company shares at a predetermined price (exercise/strike price) after vesting.

SARs: A right to receive the increase in value of a set number of shares over time, often settled in cash or stock.

2. Value at vesting

RSUs: Always have value (equal to the full market price of shares at vesting).

Stock options: Only have value if the company’s share price exceeds the strike price.

SARs: Value depends on the appreciation of stock price above the grant price.

3. Employee cost

RSUs: No cost to receive shares. Automatically delivered at vesting.

Stock options: Employees must pay the strike price to exercise.

SARs: No cost to exercise; employees receive only the value gain.

4. Payout type and dilution impact

RSUs: Typically settled in actual shares, which increases the total number of outstanding shares and contributes to equity dilution. Some companies may settle RSUs in cash, but this is less common.

Stock options: When exercised, options convert into new shares, contributing to equity dilution.

SARs: Can be settled in either cash or stock, depending on the plan. If settled in cash, they avoid dilution entirely. 

5. Administrative complexity

RSUs: Simple to communicate and administer.

Stock options: Requires tracking strike prices, exercise windows, and post-termination rules.

SARs: Can be complex to design and manage, especially if cash-settled.

Frequently asked questions

1. What are RSUs and how do they work?

RSUs (Restricted Stock Units) are a type of equity compensation where companies promise to give employees company shares in the future, as long as certain vesting conditions are met. These conditions are usually based on time, performance, or company milestones. Once RSUs vest, employees receive actual shares or, in some cases, a cash payout equal to their value.

2. Is RSU part of CTC?

It can be, but it depends on the company.

Some employers include the notional value of RSUs in CTC (Cost to Company), usually based on the grant value spread over the vesting period. Others treat it as additional upside and keep it separate from fixed components like base salary, bonus, or benefits.

3. Does 1 RSU equal 1 stock?

Yes, 1 RSU typically equals 1 share of company stock once it vests. However, it's always best to check your grant letter, as the exact terms should be clearly specified there.

4. What are the disadvantages of RSUs?

RSUs come with a few important drawbacks.

First, there is no ownership or value until the RSUs vest, so if an employee leaves the company early, they forfeit any unvested units.

Second, RSUs are taxed as income at the time of vesting, which can create a tax liability even if the shares cannot be sold. This is particularly challenging in private companies where there is no active market.