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What is Stock Option, RSU, and Restricted Stock? - YouTube
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What are Stock Option, RSU, and Restricted Stock?
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They are different types of equity instruments.
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Employees can use them to own a piece of a company.
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The purpose is to align an employee's interest
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with the company's interest.
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If the company is doing well,
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then the equity is more valuable.
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It motivates people to work hard.
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A stock option is a contract
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that lets you buy some stock at a later date at some price.
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The "later date" is Exercise Window,
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and "some price" is the Strike Price.
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For example, a stock for Company A
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is currently sold at $110 per share.
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Normally, to buy one share,
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I will need to pay 110 dollars.
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However, let's say Company A gave me a stock option
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with strike price of $100 and exercise window of 30 days.
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This means within 30 days,
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I can pay just $100 to buy 1 share from the company
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instead of 110 dollars.
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Then, I can sell the share on the market for $110.
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I will earn $10 profit.
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The company cannot refuse to sell
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because they are bounded by the option contract.
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Note that if the stock price fell below $100,
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it doesn't make sense for me to exercise my option.
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because I will lose money.
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RSU stands for a Restricted Stock Unit.
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This is an agreement that the company will pay you
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a certain amount of stock at some future date.
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Future date is based on a vesting schedule.
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Company often offers this as part of a job offer.
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For example, one offer may be: 100 RSU of Company A
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vested over 4 years.
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One vesting schedule could be:
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you get 25 shares for each year you work.
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After four years, you will receive 100 shares.
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Restricted Stock is another form of equity.
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They are actual stocks but with a vesting schedule.
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For example, one typical offer may be:
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100 Restricted Stock vested over 4 years.
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This means: on Day 0,
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you receive 100 Restricted Stock right away.
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However, before the 1-year mark,
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The company can legally buy back 100%
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of your restricted stock for $0.
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After the 1-year mark, the company can buy back only
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75% of your restricted stock for $0.
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After the two-year mark, the company can only
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buy back 50% of your restricted stock for zero dollars.
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After four years, they can no longer buy anything back for $0.
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The major difference between RSU and restricted stock is tax.
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Let's walk through an example.
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Let's say Alice is awarded 100 RSUs,
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vested over four years, with 25% each year.
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Under the current tax law,
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Alice is taxed whenever stock vests.
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On Year 0, Alice has not received any stock.
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So Ellis does not pay tax.
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On Year One, however, Alice receives 25 shares.
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Before the company gives the shares to Alice,
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The company takes a portion of it
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and liquidates it to pay tax.
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Similarly, at Year Two, Alice receives 25 more shares
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minus some for tax.
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Let's walk through another example:
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Suppose Bob has 100 Restricted Stock,
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vested over 4 years.
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Under the current tax law,
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Bob is taxed when the stock vests.
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On Year 0, Bob receives all 100 shares.
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Bob could wait until year 1 or year 2 to pay tax
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just like RSU.
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However, Bob also has the option of
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paying all of the taxes up front.
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This is known as 83(b) Election.
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If Bob does this, he does not need to pay taxes later on.
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If Bob joins a startup, chances are
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an early start up's valuation will be very low.
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Therefore, the taxes bob has to pay is also very low.
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If Bob doesn't do 83(b) Election,
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then when startup becomes huge,
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the tax will also become very expensive.
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Typically, founders, executives, or early employees
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get Restricted Stock.
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Later employees get stock options
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Larger companies give its employee RSUs or stock options.
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One important thing to know is that equity worth money
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only after a Liquidity Event.
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This means IPO or acquisition.
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IPO means company going public.
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Once that happened, you can trade your 100 shares
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with the public for actual money.
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Acquisition means a larger company buys a smaller company.
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Once that happened, the acquisition money is used to payout shareholder.
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Lastly, I want to mention a horrible industry standard.
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You typically need to exercise your stock option
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within 90 days after you leave the company.
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Otherwise, the stock option is gone.
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Say you are working at a start-up with a private company.
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You have worked at the startup for years.
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Perhaps you want to join another company.
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Perhaps you met a bad boss.
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When you leave the company,
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you only have a short window to decide
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whether to exercise your option or not.
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At this point, you don't know whether the company
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will eventually go public or be acquired.
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You don't know how much your option is worth.
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if you decide to exercise the option,
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you need to have enough cash to buy the actual share
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of the stock.
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Also, you need additional cash
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to pay for the taxes,
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which is due when you exercise.
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If the value of the company drops
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it is possible you are overpaying in taxes.
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fab.com used to be valued as a billion dollar company.
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However in 2015,
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it was acquired by PCH for an undisclosed amount.
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TechCrunch estimated it to be as little as $15 million.
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This means if someone left fab.com
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while it was still a unicorn.
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then he will be paying five or six times
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in taxes than he should.
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To avoid this, before joining a start-up,
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negotiate to extend the window of exercise
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to be 10 years instead of 90 days.
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This will give you much more options.
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Thanks for watching!
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