RSAs vs. RSUs: What to Know About Restricted Stock

May 5, 2023

Among the things you simply have to know as a startup founder, equity compensation is pretty high up there. More to the point, it’s crucial to understand the different types of equity compensation and how they work—for the sake of your employees, yes, but also for the sake of your business.

And if you’re thinking, Hey, I know everything there is to know about stock options so I’m good, well, you might still want to listen to what we have to say in this guide. Why? Because we’re about to cover the basics of restricted stock awards (RSAs) and restricted stock units (RSUs), two forms of equity compensation that work in ways fundamentally different from stock options.

RSAs and RSUs may have certain things in common, but they also differ from each other in several key ways. By the end of this guide, you’ll have those key differences down pat—and you’ll be ready to determine which type of restricted stock makes the most sense for your employees.

RSAs vs. RSUs: At-a-glance comparison

Overview

What is restricted stock and how does it differ from stock options?
What is a restricted stock award (RSA)?
What is a restricted stock unit (RSU)?
3 key differences between RSAs and RSUs
RSAs vs. RSUs: Which is better for a growing startup?

What is restricted stock and how does it differ from stock options?

As you may recall from our guide on the subject, employee stock options are a type of equity compensation that gives an employee the right, but not the obligation, to buy a number of shares of company stock at a specific price. A key thing to understand about stock options is that the employee doesn’t own the shares; he or she has the right to buy them, yes, but “the right to buy” is a far cry from outright ownership.

Perhaps you sense where this is going. One of the major differences between stock options and restricted stocks is that, in the latter case, the employee doesn’t need to exercise their right to buy shares of company stock. The employee technically has a claim to the shares from the date they’re issued (though this claim is contingent upon vesting).

We say “technically” because this ownership is restricted by certain conditions and/or requirements. Common restrictions include vesting requirements, which can be satisfied by the passage of a certain time period (known as the vesting period) or by a set of performance milestones. The idea is that the employee will be incentivized to stay or perform better in their role if they know that their access to shares of company stock is at stake.

The two types of restricted stock are restricted stock awards (RSAs) and restricted stock units (RSUs). The restrictions, taxes, and other details related to RSAs vs. RSUs can differ greatly, so don’t be confused by their deceptively similar names.

What is a restricted stock award (RSA)?

A restricted stock award is a grant of company stock that is restricted in certain ways. If the employee accepts the grant—which may require paying a purchase price for it—then they technically own the stock from the grant date. But their rights to that ownership may be stripped from them if they fail to meet certain restrictions or vesting conditions.

These restrictions are usually time-based vesting schedules. So, a certain period of time— usually several years, with a regular vesting schedule following a one-year cliff—must pass before the restrictions lapse and the stock becomes unrestricted. If the employee leaves or is terminated before their shares are fully vested, then the company will typically have the right to repurchase any unvested shares. Again, this is to disincentivize employees from joining a company, cashing in their RSA award, and jetting off before they add any real value in their role.

It’s important to understand that, with RSAs, the employee owns actual shares of company stock immediately upon the date of the grant. Because these are actual shares, they come with some perks that other types of equity awards may not, such as voting rights.

How do RSAs vest?

As noted above, the vesting requirements for RSA shares are typically met by the passage of time. This isn’t always the case, as vesting may also be tied to individual performance milestones. In some instances, if the company determines that the employee’s performance warrants it, vesting can occur prior to the vesting date stated in the grant.

Once the vesting conditions are met, the employee owns any vested shares outright. This means that the employee can do whatever they wish with the shares—sell them, hold them, etc.—without having to worry about any restrictions.

This is markedly different from restricted ownership of the shares, which (as you’ll recall) kicks in immediately upon the grant date. Typically, restricted or unvested shares can’t be sold for cash or otherwise. They may also be forfeited or bought back by the company if the vesting conditions aren’t met.

How RSAs are taxed and the importance of the 83(b) election

If the employee doesn’t do anything and just follows normal federal income tax rules, they will owe ordinary income tax on any taxable gain between the date of the grant and the vesting of the shares. No taxes will be due at the time of the grant, but taxes will be paid over the course of the entire vesting period.

Taxes are calculated as a percentage of the shares’ fair market value (FMV) rather than as a set amount, so the total tax liability will be higher if the fair market value of the shares gradually increases over time.

To understand how this works, let’s consider the case of a software engineer named Stephanie. Stephanie is granted an RSA of 8,000 shares of restricted stock that vest over four years. As part of her RSA agreement, Stephanie pays a purchase price of $1 per share, which is equal to the fair market value (FMV). The vesting schedule in her grant stipulates that 25% of her shares will vest each year, and the fair market value of one share of stock increases over those four years as follows:

According to normal federal income tax rules, Stephanie wouldn’t pay any taxes on her shares at the grant date, but she would pay the following ordinary income taxes on her shares as they vest (for the purpose of the example, we’ll use the maximum ordinary income tax rate for 2022, which is 37%):

After Year 1, she will pay $740 ($1[$2–$1]/share x 2,000 = $2,000) x 37%
After Year 2, she will pay $2,960 ($4[$5–$1]/share x 2,000 = $8,000) x 37%
After Year 3, she will pay $6,660 ($9[$10–$1]share x 2,000 = $18,000) x 37%
After Year 4, she will pay $21,460 ($29[$30–$1]/share x 2,000 = $58,000) x 37%

So, Stephanie would owe a total of $31,820 on her vested shares. That’s a lot of taxes owed. But what if we told you there was a way for Stephanie to pay all of her ordinary income tax up front—when her taxable gain is $0?

This is made possible by the Section 83(b) election. Section 83(b) is a provision of the tax code that gives startup founders and employees the option to pay taxes on the fair market value of their restricted stock at the time it’s granted versus when it vests.

If Stephanie files an 83(b) election within 30 days of her grant date, she will owe nothing in terms of ordinary income tax because her taxable gain will be $0 (she paid the FMV for her shares as part of the purchase price, so there’s no taxable gain). She’ll owe capital gains tax if and when she decides to sell the shares later down the line, but the 83(b) election gives her a path to avoid ordinary income tax on her RSA altogether. Not bad!

What happens to RSAs if the employee is terminated?

Even though the employee may technically own their RSA shares, these shares are restricted based on vesting requirements. If the employee decides to leave the company or is otherwise terminated prior to their shares becoming fully vested, those requirements are at least partially unfulfilled. This means that any unvested RSA shares can be repurchased by the company, usually at the same price the employee paid for them.

What is a Restricted Stock Unit (RSU)?

A restricted stock unit (RSU) is a type of stock-based compensation that grants the employee a certain number of shares of company stock. These shares are typically subject to a vesting period or schedule, meaning that certain milestones must be met before the employee is granted the RSU. As with RSAs, these milestones are typically time-based. But they can also be based around performance incentives at the company’s discretion.

Unlike an RSA grant, an RSU grant does not involve the immediate issuance of company stock to the employee. Instead, restricted stock units convert into common stock after the vesting conditions are met. Since an employee with an RSU grant doesn’t technically own any stock until it’s vested, the employee doesn’t immediately get voting rights.

How do RSUs vest?

RSUs typically convert into shares of common stock according to a specified vesting schedule. A time-based vesting schedule of four years is probably the most common, though companies may have different vesting schedules or milestones.

One thing to note about RSU vesting is that it may also be subject to other conditions outside the employee’s control. For example, a liquidation condition might specify that a certain liquidation event (such as an IPO) has to occur before the shares are considered fully vested. There should be information about how all of this is handled in the language of the RSU grant.

How are RSUs taxed?

An employee with an RSU grant does not have to pay taxes at the time of the grant. They must, however, pay taxes when each tranche of RSUs is settled and delivered (usually upon vesting). RSUs are taxed at ordinary income tax rates, which can vary by state (though the same federal rate applies regardless of state).

Once RSUs convert into shares of common stock, the employee can either hold or sell them. If the employee decides to sell their shares of common stock at a later date, the employee will pay taxes at the capital gains tax rate on any appreciation in the share price from the time the stock was acquired to the time it was sold.

What happens to RSUs if the employee is terminated?

Any unvested RSU shares are typically forfeited if an employee voluntarily leaves or is terminated. The employee gets to hold onto and benefit from the value of any vested shares, assuming those shares aren’t subject to a liquidation condition that never comes to pass.

In some cases, the terminated employee may benefit from accelerated RSU vesting if certain events known as vesting triggers occur. The two most common vesting triggers are change of control (i.e. the sale or acquisition of a company by an outside party) and the involuntary termination of the employee. When both of these triggers are required for vesting acceleration to occur, it’s known as double-trigger acceleration.

3 key differences between RSAs and RSUs

So, now that we’ve gone through the ins and outs of RSAs vs. RSUs, let’s recap some of the key differences between these two types of restricted stock:

1. Vesting and share ownership

RSAs: The employee owns actual shares of company stock immediately upon the date of the grant. These shares are still subject to vesting requirements, and if the vesting requirements aren’t met, the employee may have to forfeit ownership of the shares.
RSUs: The employee only owns actual shares of company stock after the vesting conditions have been met. This means that it may take up to four, five, or more years for the employee to own all the stock promised to them in an RSU grant.

2. Taxation and eligibility for 83(b) election

RSAs: Are eligible for an 83(b) election and may only be subject to capital gains tax if the 83(b) election is filed on time.
RSUs: Are not eligible for an 83(b) election and are taxed as ordinary income at their full FMV when they vest.

3. Treatment of the restricted stock upon termination

RSAs: Unvested shares at the time of termination can be repurchased by the company (usually at the same price the employee paid for them) or may be otherwise subject to forfeiture.
RSUs: Unvested shares at the time of termination are forfeited.

RSAs vs. RSUs: Which is better for a growing startup?

It can be difficult to figure out which type of equity compensation is appropriate to offer prospective employees. To make matters even more confusing, the answer to this question will likely change based on whether your startup is in its early stages or further along in maturity.

Typically, RSAs make more sense for early-stage startups, where the taxation benefits, shareholder rights, and upside potential of the company stock combine to form an attractive package. RSUs tend to be more common at public companies and later-stage startups, where the FMV of a share of common stock is already quite high. Stock options can also make a good deal of sense in the growth period between those two states, as you can read about in our guide to RSUs vs. stock options.

We know that was a lot to absorb, but this is really just the start of the journey. Pulley has helped countless startups find the equity types that make sense for them, and we’d like to help you, too. Schedule a call with us today.