Title: Why RSUs are replacing stock options
Sub: Dynamic RSUs solve most of the problems of stock options; RSUs are changing the way we think about and deploy equity
The world is giving up on stock options. People want instantaneous transactions, meanwhile stock options have remained slow to implement and painful to understand. Industry leaders, like Steve Blank, have made it clear that it’s time to replace stock options with Restricted Stock Units (RSUs). In response, more RSUs haven been issued than stock options in the last few years. RSUs substantially help limit risks for companies and workers alike. RSUs have been around for a couple decades, but they’ve mostly only been used in high end technology and life science companies. It’s just a matter of time before RSUs completely eclipse stock options as the preferred method of equity award.
Stock options solved an old problem
Back in the day, stock options were the trendiest way to reward and engage a company’s executive leadership team and early stage employees. With time, companies expanded stock options to include most full time company workers, allowing them to buy company stock at a set stock price based off of the present valuation at a point several years in the future, with the expectation that the company's stock price would drastically increase in years to come. This encouraged workers to be loyal to their company while striving to ensure their company’s continued success.
Then the rules changed
In 2005 the Financial Accounting Standards Board (FASB) standardized the practice of recognizing stock-option compensation as an expense on income tax statements instead of a tax deduction. Stock options became a drag on earnings.
Workers started to sour on options
Additionally, in some instances, workers could lose cash, or may not be able to afford to pay for their vested stock, or when needing to pay tax on salary used to acquire their vested stock. When workers have to put their cash on the line, they often choose to walk away rather than to buy their vested stock. In these circumstances workers have little to no reasons to stay past their initial vesting period, often choosing to vest and run off to another up and coming company.
Stock option benefits collapsed
Stock options only provide huge benefits to companies that can achieve a drastic increase in their stock price. So what about companies that don’t continually experience skyrocketing growth? If a company’s growth has slowed down, or as all too often happen, is never able to increase, workers usually feel disappointed that their efforts have been in vain, and will choose to seek opportunities at another company. Ultimately, stock options only work as a motivational tool for workers when their stock price increases. When a company’s stock price stays flat or even decreases it can have a discouraging effect on worker motivation.
Simply put, stock options have become more like a lottery ticket than a fair and beneficial means of compensation. They’re difficult for people to understand, and feel like a gamble.
In the words of an Apple exec, Sam Jadallah,
“I am a major fan of the uniqueness and power of alignment that stock options brought to employees, management and shareholders. Over time, however, that alignment and benefit degraded to the point where stock options have become a lottery ticket rather than compelling & predictable wealth creation.”
It’s for this reason that over time people have been looking for alternatives to stock options and have been using different approaches to sharing company equity, such as RSUs. Sticking with stock options as the central means to compensate and reward workers no longer works. It’s time to move onto something new.
RSUs to the rescue
So how can we mitigate risks for workers and inspire their best efforts while supporting a company’s growth? That’s where visualized RSUs, RSUs with a real-time motivational dashboard to track equity earning, come in.
RSUs (Restricted Stock Units, not to be confused with restricted stocks) are a promise to receive company stock (or their cash equivalent) at a future date in return for fulfilling specific obligations to the company. This makes bookkeeping and balancing cap tables easier for the company since there is no need to hold shares in custody, worry about voting rights, or cancelation of outstanding shares if a worker ends employment before their shares have vested or a landmark event (acquisition or IPO) has occurred. All while ensuring that workers do not have to put their personal cash at risk in order to receive equity. In this way, RSUs align the interests of current shareholders, workers and management by granting greater economic incentive for workers to stay with the company rather than moving onto a new company every two to three years. The integration of a visual dashboard to track RSU growth further helps to align worker and shareholder interests, by allowing workers to easily track their earnings.
Over the last 20 years, RSUs have become more accessible, they’ve been moving down market as they say. According to a 2017 study about worker equity trends by Radford, in 2003 only 3% of technology companies were using RSU centered equity plans. As many may recall, when the market crashed in 2008, many companies using stock options had devastated employees who discovered that their hard earned option grants, previously worth millions, became practically worthless overnight. By 2017, 72% of technology and life science companies had switched over to RSU centered plans.
Currently, most major companies (Amazon, Apple, Facebook, Google, ect.) use RSUs rather than stock options. Unfortunately, while large companies are able to take advantage of the benefits of utilizing RSUs in their equity plans, down market companies have not been able to afford making the switch. These large companies can afford to convert existing stock option plans to RSUs, or to hire a team of attorneys to create new custom equity plan documents. Small to medium businesses are simply unable to afford the upfront cost of creating a nuanced equity plan that maximizes worker output and retention.
So what’s next?
Startups and other small to medium sized businesses need access to the equity tools that large companies have access to without the high price of creating a solution from scratch.
These businesses needed a RSU system that is optimized for smaller companies between 1 and 1000 workers.
Dynamic RSUs solve many of these problems
RSUs allow equity plans to be more adaptable than ever before. When companies add a performance equity front end dashboard, this has been referred to as a dynamic RSU system. With this, equity may be granted based on time spent, performance markers reached, or a combination of both. Enabling you to make truly unique equity plans that fit the specific needs of any company.
Furthermore, companies are also able to protect themselves and their workers from tax liabilities by using a lesser known legal construction called “double trigger vesting.” The first trigger is met by achieving a time or task goal. For example, a time goal could be staying with the company for a certain number of years. The second trigger is met once a liquidity event occurs such as an IPO or acquisition. Once the liquidity event occurs, equity pools freeze and vesting stops, or in some cases gets accelerated. Next a portion of the RSUs owed to workers may be liquidated in order to help them pay the tax for receiving their shares. The remaining equity will be distributed to workers in the form of stock or cash.
These dynamic RSU systems also allow for RSU buy back periods. This way workers are compensated for the time they’ve invested by working at the company, and the company has the option to offer to buy back a worker’s equity.
When a worker wishes to leave the company prior to their vesting period, using dynamic RSUs, the worker can keep a portion of their equity (as specified by management before their contract was signed). Some companies choose to allow workers to keep all of their equity while others may choose a lesser percentage, say 50% or even 0% depending on the particular scenario.
Upstock makes dynamic RSUs easy
Upstock is a remote team app that is both a top shelf legal document signing system paired with a world class dashboard that allows companies to effortlessly administer equity, so workers can see their ownership grow in real-time. Great founders know that their leadership is more powerful when there is true alignment between the company and workers. Now companies of all sizes can maximize worker engagement and therefore output by rewarding workers with transparent, fractional ownership in their company.
Benefits of using Upstock Dynamic RSUs:
Our proprietary software makes it easy for you to set up your own employee equity program in minutes. By utilizing industry standard terms and agreements, we are able to eliminate 90% of the cost of building, implementing, monitoring, and distributing equity plans. If this piques your interest, see why many companies are choosing Upstock and take advantage of our current COVID offering: free onboarding (normally $100 per worker in value) and a cost of $10 per worker per month.
At Upstock we believe that the future is owned by all of us! Even if your company is doing okay, why not do great? We can help you skyrocket your company’s growth from within. See if your company qualifies, and get in touch with us today at upstock.io.