Motivate key employees in both good and bad times.
A Restricted Share Unit (RSU) is a commitment from a company to grant you shares at no cost (possibly only the nominal value of the share), based on an agreed-upon set of terms. The shares from an RSU can't be sold or transferred until they're officially given to the employee on a specified date. While stock options might lose their appeal if the company's stock price drops, RSU's retain their value because it remains "in the money". Essentially, as long as the company holds value, the RSU ensures that the holder will receive something of value when the time comes. Also, the administration costs for the employer are minimal as there are no actual shares to follow. And because the shares are not to be allotted before the redemption date, a dilution of the shares is also postponed.
Before the major financial scandals in companies such as Enron and WorldCom in the United States in the mid-2000s, stock options were the preferred form of equity compensation. The scandals and several cases of tax fraud led companies to consider other types of equity incentive plans that could contribute to recruit and retain employees. RSU's became especially popular. These had previously been reserved for management, and were now assigned to employees at all levels. RSU's has also been criticizedm which stem from the perception that they represent a "free lunch". Shareholders typically prefer programs that are more directly tied to the company's or individual's performance.
We consider RSU's to be good instruments when your main point is to attract or “tie in” key employees over a long period of time. RSU's are received regardless of how the company performs, and there are no specific goals related to the earnings other than remaining in your position.
A little about taxes
- Upon redemption, a ‘fair market value’ is set – typically the share price at the time of transfer of the shares. They are then counted as salary, and the value of the RSU's received is taxed as salary. This means that if the share price at the time of transfer is EUR 100, and you tax 40%, then EUR 100 will be reported as salary and EUR 40 will be your “tax bill”.
- It is also possible to withhold a portion of the shares to cover income tax.
In both of the mentioned alternatives, the shares received can, as a general rule, be traded freely.
Benefits of RSU's
- Unlike options that can expire without any value, RSU's will always have a value based on the underlying stock. This makes the instrument a super mechanism for making sure your key resources have a big upside in staying, and a potentially big downside in quitting.
- RSU's are risk-free and taxed, meaning there will be no taxation before the redemption date. They provide perceived value even when the share fluctuates in value, and do not involve any pre-investments for the employee or the company.
- The fact that RSU's, as options, are nothing more than an agreement before they become an actual share, makes it efficient to administer. There is no need for a structure for share accounts etc. before the RSU's become actual shares (note, however, accounting management under IFRS).
Disadvantages of RSU's
- No downside for participants (this can be considered a disadvantage among owners).
- No performance elements beyond staying in position.
- Income tax for participants (and employer’s contribution for the company) on the value at the time of transfer. Given good share price development, it would be tax-advantageous to transfer the share earlier.
- In scenarios where the share price rises significantly, RSU's will give a lower gain than with options, as you typically receive more options than RSU's.
- As a general rule, no voting rights during the period the instrument is an RSU.
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