Companies offer various rewards to recognise employee performance and loyalty. These incentives can boost morale and encourage dedication. While cash bonuses are common, some businesses grant employees ownership in the company through restricted stock units (RSUs).
In the following sections, we will dive deep into the concept of RSUs, what they are and why they are important.
What Is Restricted Stock Units or RSU Meaning?
RSUs are a form of employee compensation where the company awards shares of its stock. However, there’s a catch: employees can’t sell these shares immediately. There’s a predefined vesting period during which the shares are restricted.
Companies establish vesting schedules to ensure employees earn ownership rights gradually. These schedules can be based on time, performance milestones, or a combination of both. For instance, employees might gain full ownership of their RSUs after a certain number of years with the company or upon achieving specific performance goals.
Companies do so to ensure that the employee stays long enough with the company. The company can thus give out the privilege of being a shareholder to the employee only when certain parameters are satisfied. For example, a vesting period for RSUs can end early if the concerned employee surpasses the predetermined performance milestones. Similarly, a vesting period that is based solely on time can also end after an employee remains with his/her particular employer for a specified period.
Also Read More About Restricted Stock Units Vs Stock Options
What Are the Restrictions on RSUs?
Restricted stock units (RSUs) come with vesting schedules that create hurdles employees must overcome to gain full ownership of the stock. These restrictions incentivise long-term commitment and performance.
1. Time-Based Vesting: Loyalty Reward
One common restriction is time-based vesting. Employees must remain with the company for a predetermined period, typically several years, before the RSUs vest. This encourages loyalty and aligns employee interests with the company’s long-term success.
2. Performance-Based Vesting: Reaching Milestones
Some RSUs have performance-based vesting tied to achieving specific goals. For example, a sales representative might have RSUs vest upon exceeding a certain sales target within a year. This motivates employees to excel and contribute to the company’s objectives.
3. Combined Restrictions: Double Duty
In some cases, RSUs have both time-based and performance-based restrictions. Employees must fulfill both conditions, remaining with the company for a set time and achieving specific goals, to gain full ownership. This approach strengthens the alignment between employee performance and company growth.
While RSUs grant employees a stake in the company’s future, these restrictions ensure that employees share the company’s long-term vision. By fulfilling the vesting requirements, employees can unlock the full potential of their RSUs and truly own a piece of the company.
What To Do with RSUs?
Once RSUs vest, employees gain the option to sell their shares and potentially capture a significant gain. However, the decision to sell is not straightforward.
For some employees, especially those with volatile company stock, selling all vested shares might be prudent. Fluctuations can erase any potential gains from holding.
On the other hand, if the stock price is already high, there’s a chance it may not climb much further. In this scenario, holding might be a better strategy.
Ultimately, the decision of whether to sell or hold vested RSUs depends on individual circumstances and risk tolerance. Regardless of the choice, RSUs offer employees the potential for substantial profit.
Taxation on Restricted Stock Units
The following table shows the RSU beneficiary’s tax liabilities, as per the different situations –
| Situation | Tax Liability |
| RSU after vesting | Income tax to be paid after adding such shares to taxable income. |
| Acquiring RSU | Zero tax liability. |
| Selling RSUs within 2 years of acquisition | Sale value is added to the income tax amount and is taxed as per the applicable slab. |
| Selling RSUs later than 2 years after acquisition | Taxes are applicable as per the long-term capital gain norms, along with the indexation facility. |
Advantages of RSUs
Restricted stock units (RSUs) offer a compelling incentive package for both employers and employees. Here’s a closer look at some key benefits:
- Enhanced Retention: RSUs create a long-term commitment between employee and company. The vesting schedule encourages employees to stay invested in the company’s success, potentially for several years. This reduces employee turnover and fosters a more stable workforce.
- Motivation and Performance: By granting ownership in the company, RSUs directly tie employee rewards to the company’s performance. This alignment incentivises employees to go the extra mile, contributing to increased productivity and overall company success.
- Potential for Capital Gains: When employees hold onto their RSUs until they fully vest, they have the opportunity to capture significant capital gains, especially if the company’s stock price rises during the vesting period. This shared ownership fosters a sense of partnership and motivates employees to make decisions that benefit the company’s long-term growth.
- Reduced Administrative Costs: Unlike stock options, RSUs don’t require companies to track and record individual shares. This translates to lower administrative costs for the company, making it a more cost-effective employee incentive program.
Disadvantages of RSUs
While RSUs offer numerous benefits, there are also some limitations to consider:
- Forfeiture Risk: Employees who leave the company before their RSUs fully vest forfeit any unvested shares. This can be a significant drawback, particularly for employees who leave unexpectedly or decide to pursue other opportunities mid-vesting period.
- Lack of Liquidity and Dividends: Unlike actual company stock, RSUs don’t provide regular dividend payments. Additionally, employees cannot freely sell their RSUs until they fully vest, limiting their access to immediate financial benefits. This can be a disadvantage for employees who rely on their compensation for short-term financial needs.
- Uncertainty and Dependence: The value of RSUs is directly tied to the company’s stock performance. If the stock price falls during the vesting period, employees could end up receiving shares with less value than initially anticipated. This element of uncertainty can be a drawback for some employees.
By understanding both the advantages and disadvantages of RSUs, companies and employees can make informed decisions about whether this type of compensation aligns with their goals and risk tolerance.
Final Words
Now that you understand RSU meaning and the value of RSUs, check out how you can invest in other publicly traded stocks by opening a free demat account with Angel One!
FAQs
What are RSUs?
RSUs (Restricted Stock Units) are a form of compensation where a company grants you ownership of its stock, but with a waiting period. You can’t sell them until the vesting period is over.
Why do companies offer RSUs?
Companies use RSUs to incentivise employees to stay long-term and work towards the company’s success. Owning a piece of the company aligns your goals with theirs.
How long does it take for RSUs to vest?
Vesting schedules vary, typically ranging from a few years to the entire employment period. You gradually gain ownership rights over time.
What happens if I leave before my RSUs vest?
Unfortunately, you forfeit any unvested RSUs if you leave the company before the vesting period ends.
What are the tax implications of RSUs?
You’ll be taxed on the fair market value of your vested RSUs when they vest, not when you sell them. Consider potential tax obligations when deciding to hold or sell.
