The Basics of Equity Compensation

Restricted Stock Units

These awards are a form of compensation granted as company shares to employees at no cost after vesting requirements have been met. The vesting schedule is typically graduated, and vesting is based on achieving certain performance goals or time in service with the company. When a vesting period ends, the company holds back some of the stock to pay income taxes and the employee receives the rest as income in the form of shares to sell as they see fit.

Restricted Stock Units (RSUs) are granted to all levels of employees and are a popular form of equity compensation because, like restricted stock, they always retain some value. When the vesting period ends and the employee receives their portion of the shares, they also receive voting rights. If an employee leaves the company, they lose the unvested portion of the shares.

Taxes

RSUs are taxed in the year of vesting as ordinary income. The amount of tax is based on the market value of the shares at vesting. If the employee sells the shares later, any increase in value from the vesting date will be subject to capital gains tax.

Stock Appreciation Rights

Stock Appreciation Rights (SARs) are awards that have the value of a company’s stock appreciation over a specified time interval. If the company’s stock price has gained over that time period, that gain is paid out, like a bonus, to an employee who has been granted the right to benefit from the gain. The amount the employee receives is based on the number of shares assigned (there is no stock ownership involved) in the award plan. The award is usually in the form of cash, but it can be in shares. Like other forms of equity compensation, SARs may be subject to clawbacks.

SARs are a high-risk form of employee compensation because if the price of the company’s shares does not increase, the SARs will expire with no value. Because share value is tied to company performance, SAR awards are most often granted to employees with the most impact on performance, the company’s senior management.

SARs are often awarded along with stock options to help employees pay for:

1. an option exercise
2. taxes due

For the company, one of the drawbacks to SARs is that if given as a cash award, the company has to have the cash on hand. This is also true if the award is in company shares because the employee may sell the shares right away.

Taxes

SARs are taxed when exercised based on the price gain of the company’s stock from the time of grant to exercise. If the gain is $20, for example, this is multiplied times the number of SARs in the award and the ordinary income tax rate is applied.