RSUs - Restricted Stock Units - Evaluating an RSU Offer at a Startup
Working for a startup? Here’s how to think about Restricted Stock Units or RSUs.
Originally published February 10, 2014. Updated March 27, 2017 and July 5, 2023.
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
Working for a startup? Here’s how to think about RSUs.
What are RSUs?
Restricted Stock Units ("RSUs") are not stock. They are not restricted stock. They are not stock options. RSUs are a company's promise to give you shares of the company's stock (or the cash value of the company's stock) at some time in the future.
How Many Shares Do I Have?
One RSU is equivalent to one share of stock. The number of RSUs in your grant determines how many shares of stock (or the number of shares of stock used to determine your cash payment) you will receive when they are "settled" on the Settlement Date.
You’ll receive one share of stock (or the cash value of one share of stock) for every vested RSU on the Settlement Date. For startup (private company) RSUs, the Settlement Date is usually a company Liquidity Event. A company Liquidity Event might include (i) a Change of Control (aka Merger or Acquisition); (ii) after an IPO, when post-IPO lockup on employee sales expires or (iii) a company choice to have an early settlement in shares.
When are Startup RSUs Taxed?
Most startup RSUs are structured elegantly to defer taxes until after the shares can be sold to cover the taxes. That’s achieved with a two-tier vesting schedule. Before the RSUs fully vest (so they can be “settled” in shares or cash on the Settlement Date), two triggers must be met:
Time-Based Vesting AND
Liquidity-Event-Based Vesting
Time-based vesting is the classic vesting concept. You will meet the time-based vesting requirement over a set period of time of service (called the "Vesting Period"). The most common time- vesting period is quarterly vesting over four years with a 1-year cliff.
The liquidity-event vesting requirement is the tax-deferral concept. The shares will not be settled / fully vested for tax purposes until the company has a Liquidity Event. A company Liquidity Event might include (i) a Change of Control (aka Merger or Acquisition); (ii) after an IPO, when post-IPO lockup on employee sales expires or (iii) a company choice to have an early settlement in shares.
Without this liquidity-event vesting requirement, RSUs could become vested for tax purposes before there is a market to sell the shares (or even before shares are officially received in exchange for the RSUs at settlement). That would be very unappealing for startup employees and executives, as they would need to pay taxes out of their own funds based on the FMV on the vesting date.
[Careful! This two-tier vesting structure (sometimes called double trigger vesting) is a tax deferral mechanism. It is not the same thing as double trigger acceleration upon change of control! Those are often confused so be careful there.]
Do Startup RSUs Expire?
Yes! There’s two issues to watch out for w/r/t expiration / forfeiture of startup RSUs.
All startup RSUs include a deadline, so that if the Liquidity Event is not achieved by a certain date, all RSUs will be forfeited without payment. That is usually 5 or 7 years from the date of grant. Therefore, most RSUs are designed to be forfeited if the company does not go public or get acquired within 5 or 7 years of the employee or executive’s start date even if the RSUs have already time-vested by that date. Unfortunately, this term is not negotiable as it is a tax-driven deadline. The RSUs must be designed with a substantial risk of forfeiture in order to defer taxation.
In addition to this tax-driven deadline, some RSUs include a forfeiture clause. This is similar to the dreaded clawback for vested shares, even though it is technically part of the vesting schedule. Here’s how it works. If an employee or executive leaves the company, they forfeit any time-vested RSUs that have not yet been settled / vested at a Liquidity Event. In other words, the employee or executive has to survive all the way through a Liquidity Event to get anything for their time-vested RSUs. This type of forfeiture term greatly reduces the value of an RSU grant because it is not really "earned" even after the time-based vesting period.
Will I Receive Annual Refresh Grants of Startup RSUs?
Probably not! Most private companies do not make substantial refresh grants either annually or at the time of future financings. In my experience, approximately 90% of the equity individuals receive at startups is in their original, at-hire grant. This likely would be refreshed only after it is close to meeting its full time-vesting requirements.
This is usually a surprise to employees and executives coming from public companies, where regular refreshes are the norm. The reason for the difference is that startups are hoping for huge increases in valuation. If that happens, the original grant would be sufficiently valuable to retain employees and executives. If you are evaluating a job offer, there is a big difference in the value of your offer between a company that grants RSUs only at hire (and after they have vested) and a company that plans to make additional refresh grants regularly.
How Do I Value Startup RSUs?
There is no precise "value" for startup RSUs since they are not liquid (aka easily sold). But employees and executives who are evaluating startup RSUs offers do think about value when their considering how much equity makes sense for their role.
When evaluating the number of RSUs in an RSU grant, employees and executives use one or both of these approaches:
Current Valuation Method (Fact-Based): For startup stock, most hires use the price per share paid by venture capitalists for one share of preferred stock in the most recent financing as a proxy for the value of their RSUs. This is the closest number you can find for today's value. It tells you that X Venture Capitalist paid $Y for one share of the company's stock on Z date. The usefulness of this approach is somewhat limited for stale valuations, especially in the 2022-2023 market. For more on this approach, see Venture Hacks' post on startup job offers.
Percentage Ownership: Executive hires also consider their percentage ownership compared to market for their role at this stage of company. Individuals often struggle to find good resources for startup compensation data since subscriptions to the primary startup compensation data sources are only available on the company side. Here’s a blog post with publicly-available startup compensation data links that readers have found helpful.
Future Valuation Method (Guesstimate Based): To look forward and define a future payout for your RSUs, you have to do some guesswork. If you could guess the startup's value at exit and dilution prior to exit, you would know how much the stock will be worth when you receive it at settlement/post-IPO. Be careful, though, not to use price/share in isolation as stock splits would affect that in unpredictable ways.
Employees and executives often consider these facts to build those approaches of analysis:
Recent VC price per share of preferred stock
Current number of fully diluted shares in the company or the offered percentage ownership in the company
Possibilities around expected dilution, exit scenarios, exit timing and future valuation?
Need More Info?
Attorney Mary Russell counsels individuals on startup equity, including:
You are welcome to contact her at (650) 326-3412 or at info@stockoptioncounsel.com.
