Definition
Stock Options refer to an agreement that provides the holder the right to purchase company shares at a predefined price, allowing profits when the company’s stock value rises. RSUs (Restricted Stock Units) are company shares given to an employee through a vesting plan and distribution schedule after achieving certain performance milestones. The major difference is that stock options may become worthless if the company stock price doesn’t rise above the option price, whereas RSUs always hold value unless the company’s stock price drops to zero.
Key Takeaways
- Stock Options provide the right to buy company shares at a set price in the future, while Restricted Stock Units (RSUs) are company shares provided to an employee through a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with their employer for a particular length of time.
- With Stock Options, employees benefit if the stock price rises over time, providing a strong incentive for employees to work towards increasing the company’s performance and stock value. RSUs, on the other hand, have an inherent value from the onset and represent an outright ownership interest in the company.
- Stock options can become worthless if the company stock price does not rise above the option price, putting more risk onto the employee. RSUs hold more predictable value because even if the company stock price drops, they still maintain some value, offering lower risk and guaranteed reward.
Importance
Understanding the difference between Stock Options and Restricted Stock Units (RSUs) is crucial because these are two major ways companies reward their employees in addition to their regular salaries.
Stock Options give employees the right to buy company shares at a predetermined price, potentially allowing them to benefit from stock price growth.
RSUs, on the other hand, are company shares given to employees for free, but they must meet certain requirements (like a vesting period) before they can receive the shares.
Therefore, knowing the characteristics of both can help an employee make more informed decisions about compensation and tax planning, and can impact their loyalty and commitment to the company depending on the perceived future value of those stocks.
Explanation
Stock Options and Restricted Stock Units (RSUs) are both forms of employee compensation that offer equity in a company. Stock Options give an employee the right to buy a set number of shares at a predetermined price, typically lower than market value, after a waiting period or upon reaching certain milestones.
The primary purpose of Stock Options is to align the interests of the employees with those of the shareholders since the employee stands to gain when the company’s stock price rises. Stock Options are often used as a tool to retain top-performing employees and incentivize them to work towards increasing the company’s value.
On the other hand, RSUs represent ownership in the actual shares of a company, which are given to an employee at no cost, usually over a period of time or upon meeting specific performance goals. The main intent of RSUs is to enhance employee retention and drive long-term commitment to the company, as workers can only receive the full benefits of their RSUs if they stay with the company for a certain period.
Unlike Stock Options, RSUs provide employees with a guaranteed value, even if the stock price falls, as they still own the shares outright. Therefore, both stock options and RSUs serve as a way to incentivize employees to contribute towards the company’s success and stay committed to it.
Examples of Stock Options vs RSU (Restricted Stock Units)
Microsoft Corporation: In 2003, Microsoft stopped issuing stock options and instead started offering RSUs as part of their employee compensation programs. They opted for RSUs as they felt it was a better way to give their employees a piece of the company’s growth and success, without the risk that’s inherent with stock options, which could potentially become worthless if the company’s stock price fails to meet the strike price.
Amazon: Amazon is one of the most popular companies that offer RSUs to their employees, including those in warehouse and customer service roles. The company once had a plan where employees were given a small amount of RSUs on joining, with more granted every year. This was done to incentivize employees to stay and contribute to the company’s growth.
Google: Google, another tech giant, in 2007, switched from offering stock options to giving employees RSUs as a part of their Googler Stock Units program. They made the switch to ensure that all employees, regardless of when they were hired, could equally participate in the company’s equity, not just those who came on board early when the stock was low-priced. It allows employees to receive value from their equity compensation regardless of how the company’s publicly traded stock is performing. In all of these cases, the major factor determining the switch from stock options to RSUs was the element of risk. Stock options can be worthless if the company’s stock price doesn’t rise above the option’s strike price, whereas RSUs will always have value, unless the company’s stock becomes completely worthless.
Frequently Asked Questions: Stock Options vs RSU (Restricted Stock Units)
What are stock options?
Stock options grant you the right to buy company stock at a pre-set price, known as the strike price, regardless of the current market price. Stock options only hold value if the market price becomes higher than the strike price.
What are Restricted Stock Units (RSUs)?
RSUs are company shares that are given to an employee through a vesting plan and distribution schedule. RSU recipients aren’t allowed to sell or transfer the shares until they fully vest. This happens after meeting specified service or performance conditions.
What key difference between stock options and RSUs?
The main difference is the way they provide value. Stock options provide the potential for profit if the company’s stock price rises, but they can be worthless if the stock price declines or stays the same. RSUs, on the other hand, always have value unless the company’s stock price drops to zero.
Which one is better, stock options or RSUs?
Neither is objectively better; it depends on your situation and the company’s performance. RSUs are less risky because they provide guaranteed compensation, while stock options can provide higher upside potential.
How are Stock Options and RSUs taxed?
RSUs are typically taxed at the time of vesting, while stock options are taxed at the time of exercise. However, taxation can be complex and dependent on multiple factors. It is recommended to consult a tax professional for guidance.
Related Entrepreneurship Terms
- Exercise Price
- Vesting Schedule
- Equity Compensation
- Non-qualified Stock Options
- Grant Date
Sources for More Information
- Investopedia: A comprehensive resource offering financial information on everything from investments to retirement. Articles explaining the difference between stock options and RSUs can be found here.
- NerdWallet: Offering a wealth of advice on everything from banking, credit cards, and loans, to stock options and restricted stock units, this site is another excellent resource.
- The Balance: As a personal finance website that covers almost all areas of finance including investing, retirement planning and understanding taxes, you’re likely to find detailed articles explaining stock options versus RSUs here.
- My Money Blog: A blog that covers various aspects of personal finance including investing, savings, insurance, and more and frequently provides practical real-world examples.
