When you’re deciding between RSUs and NSOs at your employer, what do you do? Chat with the person at the desk next to you and make the same choice they’re making?
Their choices work for them, but your situation is unique. For you to make the best decision with these different forms of equity comp, here is a framework and illustration to help you make a great choice.
The Nuts and Bolts
RSUs and NSOs have some similarities, but are different in many ways. RSUs have some value because they are actual shares in the company. On the other hand NSOs will have value only when the stock price increases. Typically, you’ll receive a lower amount of RSUs than NSOs given these risk characteristics.
You get your RSUs from your employer over a set period – either quarterly or monthly. This rhythm is set by your employer and you don’t have control over the timing.
However, with NSOs you have control on when to use them. You use them when you want, and control the cash flows as well as the taxes associated with them.
Potential Outcomes for RSUs and NSOs
RSUs and NSOs have different outcomes. RSUs are grants of stock that eventually become owned shares on vesting. Once you own the shares, the price will fluctuate day to day, impacting their worth.
Whereas, the price of an NSO is set to the company stock price on the day the NSO is granted. The stock price must increase beyond this price to have value.
For example, today you are granted NSOs and the share price is $30, so you have the ability to buy shares at $30. The greater the increase in share price, more cash for you.
But if the stock price dips below $30 and never returns, your NSOs have no value.
On the other hand, if the price goes above $30, the NSOs have value. For instance if the share price increases to $60, that’s a lot of upside!
So RSUs have a steady outcome whereas NSOs have more upside and downside.
What Choice Will You Make?
Most of the time, you don’t have to select 100% RSU or 100% NSO. You can choose some of each. Ah, the plot thickens!
When it comes to taxes, they are the same on both RSUs and NSOs. You have to pay ordinary income tax, and withholding tax on both.
However, the timing and control of the taxes is different. RSUs vest on a schedule that is determined by your company so you have no control over the timing. But with NSOs, you can exercise them anytime after they vest, so you have the decision when (or perhaps never) you are taxed.
Cash Flow Considerations
When RSUs vest, you receive the shares. The main cash consideration is if you should pay additional withholding taxes because RSUs are considered income. This choice depends on your overall financial situation.
On the contrary, cash flow considerations with NSOs vary. When you exercise NSOs and sell them at the same time, the only cash consideration is additional withholding taxes.
Conversely, if you decide to exercise NSOs and hold your shares, you will need cash to cover the cost of the shares and the taxes due at option exercise.
What to Do with Your RSUs and NSOs When Leaving Your Employer
Typically when you leave your employer you keep your vested RSUs and exercised NSOs. Or your company sells your vested holdings on your behalf and you receive the cash.
Sadly, unvested RSUs are lost. Vested NSOs can have a lengthy post termination period, sometimes up to several years. Please check your employment agreement for the specifics.
Wrapping it All Up
Since we don’t know the future stock price, it’s hard to say what choice will be best. Overall, RSUs are more reliable, whereas NSOs offer a potentially higher reward, but are still less certain.
Your decision depends on making the best outcome based on your personal situation and how to make the best out of the equity compensation arrangement. There’s a lot to think about, and it would be great to walk though some scenarios with you.