RSU vs. Stock Options: What founders need to know

The RSU vs. stock options debate is a common one in startup circles. While stock options were originally the preferred employee incentive plan, restricted stock units (RSUs) are rising in popularity.  

As a founder, knowing how to distribute stock and efficiently manage your equity compensation programs may have a significant impact on founder ownership dilution and staff retention. To better understand the two options, we’ve outlined the main distinctions between RSUs and stock options to help you decide which type of equity offering is best for your startup. 

What are Stock Options?

Historically speaking, stock options were once the only form of equity-based compensation. A stock option offers the right to purchase company shares at a predetermined price, sometimes known as the fixed exercise price or strike price. 

This price is, ideally, less expensive than the current share price, making it a great deal for employees who get a piece of the financial pie at a much cheaper rate than outside investors. In addition, stock options are only taxed after exercised and are taxed at different rates depending on size. 

What founders should consider: 

• Employees receive full shareholder's rights (dividend rights and voting rights). 
• Any private corporation that grants stock options requires a 409A valuation to set the value of common shares.
• There are different types of stock options: Incentive Stock Options (ISOs) and Non-Qualified Options (NSOs). ISOs are stock options only granted to employees who pay taxes should they decide to sell the stock. NSOs are stock options granted to other parties like contractors and vendors, but they are taxed at the ordinary income rate when exercised. 
• Stock options act as an incentive for workers to increase the value of the startup.
• Keeping an up-to-date cap table is essential for stock options. Founders need to be aware of the total number of shares remaining available in the option pool and the total number of stock options that have previously been exercised

What are Restricted Stock Units?

With restricted stock units, the stockholder will receive the value of a certain number of units at a future date, also known as the vesting date. The vesting date is usually tied to milestones, such as the employee remaining at the company for a certain number of years or reaching specific performance goals.

RSUs retain some value regardless of the startup’s performance. Unlike stock options, RSUs do not have an exercise price. Taxes are paid on RSUs when they are fully vested.  

What founders should consider:

• RSUs require a distribution or vesting schedule to grant employees shares of stock. Employers must take careful consideration when determining the how and when of the vesting schedule to align incentives with their company timeline. .
• Employees do not receive full shareholders rights (dividend and voting rights) with RSU options 
• RSUs are settled according to the agreed terms. Employees can ask their employer to defer settling the option for a short period after vesting, giving them more time to pay off taxes. However, the employer must adhere to all GAAP tax standards. 

• It is essential to keep track of all the shares in your company with a reliable cap table.

A Side-By-Side Comparison of RSU vs. Stock Options:

Now that we’ve outlined the characteristics of RSU vs. stock options, let’s take a closer look at some of the key differences between the two:

The Employee’s Perspective

Although both equity options allow founders to offer additional compensation and have their respective benefits and drawbacks, there is another viewpoint to explore: the employees.   

Employees will often prefer RSUs, but companies don’t typically offer as many of them. An employee’s interest in stock options is typically tied to their confidence in your company's future success. 

When considering equity options, employees may think about the future financial potential of the company. Stock options can be a good choice if the stock's value rises beyond the grant price during the vesting period. On the other hand, RSUs come with a lower cost, rewarding the employee with gains. 

What’s the better choice for your startup: RSU vs. stock options

So, which is the better choice for your startup, RSUs or stock options? The answer lies within your company’s financial situation.

Stock Options: tend to be best for early-stage startups 

Early-stage, high-growth startups benefit from offering stock options, as these stocks are likely to surge in value quickly. As your company continues to grow and the common stock value rises, employees will also see their equity options grow. However, keep in mind that young startups may struggle to have enough employees to collect or withhold income and employment taxes on shares. Failing to withhold these taxes could result in hefty financial penalties. 

RSUs: tend to be best for later-stage startups 

RSUs are best for startups that have already established reliable revenue streams. Your company needs to have sufficient cash reserves to fund the taxes due on settlement. Higher-valued companies tend to have a higher market value of their common stock, which causes employees to hold off on purchasing stock options. To combat this, mature companies can offer RSUs to remain competitive in the market. 

Fidelity and equity compensation programs

As your company scales, you will need to choose between restricted stock units and stock options. By valuing your company accurately and following best practices for good governance, you can get your company off to a great start. Using our platform, you can generate a 409A valuation, easily manage your stock options or RSUs with a dynamic cap table, model rounds and assess dilution.

Fidelity’s cap table management features make it simple for employees to access equity grants and documentation right when needed. Our first-of-its-kind automated equity financing process streamlines the entire financial process to simplify and increase fundraising efficiency. 

Our platform also makes managing your shares and equity easier, which means you can feel confident granting your employees RSUs or stock options. This gives them the unique opportunity to share in your success and incentivizes employees to continue helping you scale.

Learn how Fidelity’s all-in-one platform can help you ace your equity management strategy from early-stage to IPO and beyond.