Foreword
Nowadays, many tech companies compensate their employees with restricted stock units (RSUs), effectively stock grants that vest over time. In most discussions with recruiters I’ve had, wonky maths was used to describe the actual compensation that is actually being offered, making comparisons between RSU-based and non-RSU based compensation packages difficult.
As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.
If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.
Restricted Stock Units
The typical RSU award works like this:
Let’s say your employer wants to pay you $100k over 4 years in RSUs. They will figure out a reference price of the stock at the time of the grant (i.e. when they decided to give you the award). Usually this is the price of the stock at market close on some particular day, or the average of the market closing price of some number of days.
Let’s say for our example the reference price is $100. In this case, you would be awarded with 1000 RSUs. The grant itself typically does not actually result in you getting shares. Instead, the grant is the promise of future shares. You only get the shares at set dates in the future, called vesting dates. For example, let’s say the shares vest once per quarter for the next 4 years. So each quarter, for the next 16 quarters, you’ll get 1000/16 = 62.5 shares each.
Vesting dates typically come with the stipulation that you remain employed with the employer — that is, if you quit (or are fired) before the full 16 quarters are up, you’ll forfeit any unvested shares of the grant.
To further complicate things, it’s common that a (large) part of your total compensation will come in the form of refresh grants, which are annual grants of new RSU awards, each of which are tied to a different reference price as well as award value (i.e. how much money your employer wants to actually give you). The employer may or may not disclose the reference price and/or award value, and may instead just choose to give you the total number of shares for each grant.
So, what you end up with, is a vesting schedule that looks something like this (assuming 1000 shares per grant, and consolidating all grants in the same year to shorten the table):
| Year | Grant 1 | Grant 2 | Grant 3 | Grant 4 | Total |
| 1 | 250 | 250 | |||
| 2 | 250 | 250 | 500 | ||
| 3 | 250 | 250 | 250 | 750 | |
| 4 | 250 | 250 | 250 | 250 | 1000 |
After the 16th quarter, the first grant will be fully vested and you’ll stop getting shares from it. But the 5th grant will kick in, so you’ll continue getting 250 shares per quarter.
Note that typically the first grant is much larger than the refresher grants — this is because it is actually 2 grants in 1 — the first is the typical annual grant like a refresher grant, and the second is actually you sign on bonus. For simplicity, I’m ignoring the sign on bonus component for now, so all grants are more similar in size.
Presentation
When the RSUs award schedule is presented, recruiter will usually present the actual dollar amount of the shares you’ll get. Assuming that the shares start at $100 and increase by 10% per year, then the dollar amount of the vesting schedule looks like:
| Year | Total shares vested | Dollar amount |
| 1 | 250 | $25,000 |
| 2 | 500 | $55,000 |
| 3 | 750 | $90,750 |
| 4 | 1000 | $133,100 |
And from then on, the total value will increase by 10% a year (same number of shares, but share price increases 10% per year).
Now, if you want to estimate the value of your total RSU compensation in year 3, it is natural to think that it is $90,750. Did you notice the sleight of hand?
Sleight of Hand
There are 2 main issues with computing your actual RSU compensation:
- The increase in the share price confuses the matter
- You forfeit whatever shares are not vested in all grants if you leave the company
Now, given that, what do you think is the RSU based compensation for the 3rd year? Is it
- $90,750 — the actual value of RSUs received in year 3
OR
- $121,000 — the actual value of RSUs granted in year 3
?
The answer is… neither. It is actually $82,750, which is $25,000 (the value from the first grant) + $27,500 (the value from the second grant) + $30,250 (the value from the third grant).
Think of it this way — because you forfeit any shares not vested if you leave the company, at the time of the grant, you haven’t actually earned the award yet, so $121,000 is wrong.
At the same time, the first grant is worth only $25,000, despite you getting $30,250 from the 250 shares because that’s what the company intended to pay you when it made the grant — 250 shares at $100 each. The fact that the shares have gone up in value over the next 2 years is irrelevant — the additional 30,250 – 25,000 = $5,250 is the compensation you get for taking the risk of the stock exposure! Remember that instead of going up 10% a year, the stock price could just as easily have gone down instead.
Another way of thinking of it is this — if instead of giving you a 4 year deferred grant 1, the company had just given you the $100,000 flat out. In this case, you would have the choice of whether to buy the company’s stock or not. If you did, then you’d have bought 1000 shares (at a price of $100 per share). After the 4th year, your shares would then be worth $133,100. Would you now say that the first grant was $133,100 instead of $100,000? Obviously not!
If you had valued grant 1’s shares at the vesting price instead of the reference price, then you would value grant 1’s RSUs at a total of $25,000 + $27,500 + $30,250 + $33,275 = $116,025 over the 4 years, and that just doesn’t make sense — receiving the $100,000 upfront in year 1 is clearly better, since you get the money earlier, and you have the optionality of what to do with the money, so how can it be worth less than being forced to effectively buy your employer’s stock and to hold the stock for 4 years, while risk forfeiting part of the grant if you leave the employer early?
Taxes
One argument that some make for the RSUs instead of cash upfront, is that by deferring the payment, you are also deferring taxes, and since you are getting stock, you are benefiting from the deferred payment being invested, effectively compounding the part of the upfront payment that would have been paid in taxes.
Let’s model this out. Let’s say you pay long term capital gains taxes of 20% (highest) and marginal income taxes of 25% (somewhere in the middle).
In the RSU case, you would then receive:
| Year | Vesting shares | Received shares | Total shares | Shares value (pretax) | Shares value (post tax) |
| 1 | 250 | 187.5 | 187.5 | $18,750 | $18,750 |
| 2 | 500 | 375 | 562.5 | $61,875 | $61,500 |
| 3 | 750 | 562.5 | 1125 | $136,125 | $134,512.50 |
| 4 | 1000 | 750 | 1875 | $249,562.5 | $245,227.50 |
If instead you had been paid cash upfront, paid your taxes, and then bought the shares:
| Year | Post tax grant | Total shares | Shares value (pretax) | Shares value (post tax) |
| 1 | $75,000 | 750 | $75,000 | $75,000 |
| 2 | $82,500 | 1500 | $165,000 | $150,000 |
| 3 | $90,750 | 2250 | $272,250 | $267,450 |
| 4 | $99,825 | 3000 | $399,300 | $389,055 |
I think it should be clear in terms of cash flow, getting the cash upfront is better. However, if we just look at the first grant mathematically, in year 4, it will be worth:
- If received in RSUs, with 187.5 vested at 100, 187.5 vested at 110, 187.5 vested at 121, 187.5 vested at 133.10, for a total of 750 shares worth $99,825 pretax, or $97,263.75 post tax.
- If received in upfront cash, you’ll still end up with 750 shares, but worth $94,860 post tax, due to the lower cost basis of 100 for all shares.
So the main benefit of the deferral is that you have a higher cost basis for the shares received later, which does translate to a higher after tax dollar value if sold.
Whether this benefit is enough compensation for losing control/optionality of the grant for 4 years, and having to forfeit the unvested shares if you leave the employer early, is up to you.
Comparison shopping
When comparing compensation packages between an employer that pays with RSUs, vs another one that pays with cash, it is important to remember the RSU sleight of hand, and properly value what your compensation package will actually be.
The 3 key points to watch out for are:
- If you leave the employer, will the deferred part of the compensation still be paid?1
- Properly value the dollar value of each grant by adjusting for the risk you are taking by being forced to effectively buy your employer’s stock.2
- The tax benefits of a higher cost basis for those shares that vest at a higher stock price than the reference price.
Footnotes
- Some employers may have wording in the contract to the effect of “if you do something we do not like, and you get terminated for it, then the deferred part is forfeit”. In these cases, you’ll have to estimate for yourself how likely it is that you fall afoul of those rules. In many cases, the rules are actually pretty generous and you only forfeit the deferred payments if you break a law or otherwise get involved in some serious shenanigans.
If you are confident the deferred payments will actually be made, then you should consider the payments to be made at time of grant (because that’s also when they vest). ↩︎ - If the deferred portion is paid in cash, then you may need to discount the value of that cash to the time of vesting. ↩︎
Janky Thoughts 