When you get a job offer, or a raise, or a bonus, you’re probably simply told that you’ll be receiving more restricted stock units or more stock options as part of that compensation package. But on occasion folks are given the choice: Do you want RSUs or stock options?
This is like the graduate-level version of “Do you want more equity or a higher salary?”
Talk about a decision that no one ever taught you about in school.
If you’re working in tech, you probably haven’t been taught or otherwise learned the intricacies of different types of stock compensation. Now you’re being asked to make a major decision about something you know little about, with a potentially large financial impact. If you make the wrong decision, you’re gonna feel like a dumbass. (At least, I would.) Which is all to say, this is a stressful decision!
[Note: A discussion of RSUs and stock options can get arbitrarily complicated because the nuances just. don’t. stop. I am making certain simplifying assumptions in this article that are based on my most common experiences with women in tech. One of my primary assumptions is that RSUs vest based on the passage of time, not on the achievement of certain performance metrics. Also, “option” refers to any kind of stock option; I call out “incentive” and “non-qualified” options when necessary.]
First, the Basics of RSUs vs. Stock Options
Options and RSUs are kinda apples and oranges. (If you don’t know the basics of how each of these types of equity compensation work, take a look here for RSUs and here for options.) Sure, they’re both ways to get stock in your company. But they behave differently, from the choices you must make to the amount of taxes due and when you have to pay them.
One way to start to apple-ize the comparison is to think of an RSU as a particular kind of stock option:
An RSU is like a stock option with a $0 strike price.
With options, you have to pay a “strike price” in order to turn the option into an actual share of company stock. But if the strike price is $0, that means you can get company stock without putting up any money of your own…which is exactly what happens with RSUs.
Comparing the Benefits of RSUs and Stock Options
If you measure 1 RSU against 1 stock option, RSUs are pretty much always going to win. Because an RSU is basically just a stock option with a $0 strike price, and a stock option is always going to have a strike price higher than $0. (Though, in early stage startups, sometimes not that much higher!) The lower the strike price, the less you have to pay to own the same one share of company stock, the better.
Companies know this and generally will offer you more options than they would RSUs.
A rule of thumb is that an RSU is worth about 3 or 4 stock options (in the tech industry).*
If the company is offering you an equal number of RSUs and options, RSUs are probably the right choice. If the ratio is less favorable to RSUs, then you’ll have to think through these other pros and cons to make your decision.
Benefits of Options
Here are some reasons you might prefer to have options instead of RSUs:
You might retain the right to exercise your options after you leave the company. Typically you’ll get 90 days or 3 months to make the decision after leaving. Some contracts give you 10 years regardless of employment…count yourself lucky if you have such a provision in your grant document! By contrast, RSUs usually immediately evaporate when you leave your company.
You can control when you incur income (and therefore taxes) because you decide when you exercise your options and sell the stock. By contrast, RSUs happen (they vest and you now own shares and owe taxes on their value) according to a company-dictated schedule.
[Edited to make it better 9/2/2020] You could (potentially dramatically) lower your taxes by early exercising your options. This strategy is not without risk! This is most common for NSOs, still can make sense for ISOs, but isn’t available for RSUs.
(Specific to Incentive Stock Options) Tax rates can be much lower than on either NSOs or RSUs. With NSOs and RSUs, basically everything is taxed as ordinary income. With ISOs, if you hold the stock long enough after exercising (two years after grant and one year after exercise), then all the gain above your strike price is taxed at the long-term capital gains tax rate (which can be as low as 15%…technically it can be 0% if your total income is low enough, but that’s unlikely so I’ll ignore it here…oh my god, so many disclaimers!).
Of course, don’t forget that it’s truly risky to hold individual stocks in general, and especially a single stock that is also your employer stock! Holding on to a stock simply to achieve a lower tax rate can be a Very Bad Decision. (Just ask me about holding onto HP stock my husband received from his employment there…only to see the stock drop 40% in value over that year. Ouch.)
Benefits of RSUs
Aaand sometimes RSUs are what you want:
An RSU is always worth something, unless the company goes bankrupt. An option is worth something only if the market price of the stock is above the strike price of your option. If Facebook is selling for, say, $100 but your stock option strike price is $101, your option is worthless, aka “underwater.”
You don’t have to make a choice. They just “happen” as long as you stick around. And I love this feature of Restricted Stock Units. Basically, there’s one major decision: Do I sell or hold the stock after it vests? Making decisions is draining. And I’m not being facetious. Why do you think I have a uniform of Gap jeans and extra-long t-shirts (short- or long- sleeved) from Eddie Bauer?
You don’t have to risk your own money to get company stock. Exercising an option typically requires putting money you already possess on the table and risking losing it. If your company is private, then this might be even more important, as putting your own money into private-company stock is even riskier than buying public-company stock. With RSUs, you don’t have to put out any money in order to get company stock.
Questions to Help You Make the Decision
As with most financial decisions, you need to ask yourself objective financial/numerical questions, and also squishier “feelings” kind of questions to arrive at the right decision for you.
Your Squishy Interior Self
Do decisions stress you out? If so, lean towards RSUs as there are fewer choices there. Choosing RSUs simply to manage your stress level, I believe, is Totally Valid. Even if options turn out to give you more money, it won’t make up for being miserable.
How do you feel about (un)certainty, or the age-old “risk versus return”? If you prefer certainty over possibly gaining more if the stock price increases, lean towards RSUs. Both RSUs and options benefit equally from the stock price increasing, it’s just that usually companies offer many times more options than RSUs, so you’d enjoy those stock price gains across more shares of stock.
Objective Data About Your Company and Stock Offer
When do the options or RSUs vest? The sooner the options or RSUs vest, the better for you because it reduces the risk of losing the options or RSUs (and it can open up some tax strategies). Would the RSUs vest faster than the options, or vice versa?
Is your company private or public? If it’s private, then the most important thing for you to understand isn’t “RSU or stock option?” It’s the fact that private companies are incredibly risky to own stock in because you can’t turn them into actual money before either an IPO or some other sort of “liquidity” event. And, despite appearances, most private companies don’t IPO successfully.
But, if you can truly grok that risk, then RSUs might be a better choice because they don’t require that you put any of your own money at risk in order to own that risky company stock.
Are the options ISOs (Incentive Stock Options) or NSOs (Non-qualified Stock Options)? ISOs are generally better than NSOs (mostly because of taxes). So an ISO vs. RSU question is different from an NSO vs. RSU question.
What’s the strike price for the options? The lower the strike price, the better. The less money you have to put on the line to own company stock. If we think of RSUs as a stock option with a $0 strike price, then the closer the option can get to that $0 strike price, the more “equal” the option is to the RSU.
As you can see, there isn’t a clear-cut “Check these boxes and out pops the answer” answer to this decision you have to make. In fact, I haven’t even listed all the things that might make one choice better than the other. But I’ve listed the major ones, and that’s often all you need.
Some Healthy Perspective on this Choice
Be sure to keep some healthy perspective when making this choice: The options vs. RSUs choice will likely be dwarfed by the impact of any company stock on your investment portfolio and your financial situation in general.
If your company stock does really well, then whether you have RSUs or options, you’re going to be sitting pretty. On the downside, there’s real risk in owning company stock. Please please please remain aware of how much company stock you own, how much of your portfolio is made up of company stock. Tech companies might be going gangbusters now, but they won’t always. And you really don’t want your salary, your investment portfolio, and the value of your home to take a dive simultaneously.
*According to mystockoptions.com
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Meg Bartelt, and all rights are reserved. Read the full Disclaimer.