My Company Is Going Public, Now What: What To Do With your RSUs

Updated January 2023.

Welcome back for Part 3 of our pre-IPO crash course for tech professionals. If you’ve made it this far, you have likely gained a ton of new valuable information about the pre-IPO stock world and tips to handle pre-IPO ISOs. Believe it or not, there is plenty more to discuss.

In our last post, we deeply explored pre-IPO incentive stock options (ISOs). This time, we will introduce you to restricted stock units (RSUs) and provide you with the insights and tools needed to manage them effectively.

Glossary of Terms

While there are many similarities between ISOs and RSUs, there are a few crucial distinctions. With that said, we have an updated list of key terms to aid you in understanding the contents of this post.

• Restricted Stock Units
  • Simply put, RSUs are a form of compensation issued by an employer to an employee in the form of company shares. Unlike ISOs, you do not have to exercise (purchase) these types of stock options. RSUs are granted to you with a graduated vesting schedule.

• Vesting Schedule
  • The time when your stock options become available for you to sell them. You only own the value of your stock once the vesting date hits. A typical vesting schedule might look like this:
    • The initial stock grant of 200 shares takes place on 6/1 of the current year.
    • On the initial grant date, 50 shares are immediately vested (on 6/1)
    • The remaining 150 shares vest over three years (50 shares per year on 6/1 of every year)
• Lock-up Period
  • A window of time where investors cannot sell shares of a particular investment. Most companies issue a lock-up period right after an initial public offering to avoid the shares flooding the market and ultimately depreciating the share’s value.

In general, RSUs are an excellent way for companies to demonstrate their investment in an employee and a simultaneously great way for you as an individual to diversify your finances. 

For example, you can keep some RSUs in your stock portfolio and watch their value increase over time, or you could strategically cash out some or all of them for liquidity to pay off debt or make a big purchase (like a down payment on a home). 

RSUs are also beneficial in retaining their value, unlike stock options which can come with more uncertainty. Another plus to RSUs is that once shares vest, they are yours to keep, even if you leave the company.  

That being said, with RSUs, there are a few things to keep in mind. There are some critical points regarding when and how you can use them, what restrictions employers place, how taxes are paid on RSUs, and more- all of which we’ll cover here.

RSUs + Private Companies

You may have noticed that RSUs are less complex than ISOs. Unfortunately, there are still some additional considerations for employees of pre-IPO private companies.

When Will Your RSUs Fully Vest After IPO?

In all likelihood, your RSUs will not vest until after the IPO. Every company is different, and you should clarify when your shares vest and become available to you. Is it after the lock-up period? 6 months? A year?

Knowing when your RSUs fully vest gives you more information about your stake in the company and your tax responsibilities. As we will discuss momentarily, your RSUs are fully taxable on the vesting date. Why does that matter? Let’s explore a cautionary tale regarding Uber’s IPO.

The Uber Example

For Uber employees, their stock was fully vested on the IPO date. On that date, employees with those RSUs were taxed at ordinary income tax rates (number of shares X market value on the IPO date = taxable income).

Even though the stock was vested, there was a lock-up period restricting the sale of the stock. The lock-up period extended past the IPO date. When the lock-up period ended, the stock price of Uber dropped significantly.

For example, let’s assume that as an Uber employee, you had 1,000 shares of stock vested on the IPO date at $45/share for a total value of $45,000. You would have owed ordinary income taxes on the $45,000. After the lock-up period, Uber’s stock is trading at $30/share, and your total value has dropped to $30,000. You have effectively paid tax on a value of $15,000 more than it is worth today!

Double Trigger RSUs

You may also encounter a term called double trigger RSUs. Double trigger RSUs refer to stock options that are not vested (or taxed) until you meet two criteria:

• The first criterion is for your RSU grants to vest or become available for you to sell. For employees of companies that are already public, this is relatively straightforward.
• The second criterion is for your company to experience a liquidity event. This most commonly happens in the form of an IPO (a private company going public).

Most startups and private companies prefer RSUs with double-trigger vesting as they will only trigger taxation once the second vesting condition is met and the equity is paid out. 

How Will Your RSUs Be Taxed?

There are two dates when your RSUs become taxable:

• Vest Date: As discussed in the Uber example, RSUs are taxed at ordinary income tax rates on the day they vest. Take the number of shares and multiply it by the market value of your company stock on the vesting date. That is the value at which you will pay taxes. Think about this like a bonus you would typically receive as part of your employment and performance.

• Sale Date: You will also owe taxes on the day you sell your RSUs (if you sell for a profit). Let’s assume your RSUs were worth $10,000 on the vesting date, and you sell them at some point in the future for $15,000. You will owe taxes on the $5,000 gain. If you held the shares for at least one year, you would be taxed at long-term capital gains rates. Short-term capital gains rates apply for shares held less than one year (equivalent to your ordinary income tax rates).

On the vesting date, your employer will automatically withhold taxes, which often comes from selling off shares to cover the tax burden. 

If you have double-trigger RSUs, the double-trigger provision means that no income tax is owed until the second trigger — the date of the liquidity event. 

Be sure to check your withholding rate. The Tax Cuts and Jobs Act (TCJA) of 2017 brought forth a massive change to American tax codes. This legislation affects individuals and businesses, so it’s worth refreshing to know where rates stand.   

Americanpayroll.org states the following regarding the tax rate:

 “The optional flat tax rate on supplemental wages of up to $1 million in a taxable year is tied to a section of the Internal Revenue Code that is suspended for tax years 2018 through 2025 by the TCJA (§1(i)(2)). The rate is 22% (no other percentage allowed).”

For those with wages above one million, the rate is 37% (from 2018 through 2025).

There is also a possibility to reduce your tax liability by receiving fewer shares of your RSUs. For example: “You have 300 shares vest, and they’re worth $10 a share, you’ll need to pay tax on income of $3,000. Assuming a 30% tax bracket, your tax bill will be $900, or 90 shares. You may be able to elect to receive only 210 shares, using 90 shares to cover your tax bill.”

This can be a great option, but you will need to check with your company to see if they’ll allow it. 

Since there are such specific laws set in place and nuances involved with RSUs, it is highly recommended to work with a financial professional. Creating a tax plan for your RSUs will help you avoid missteps and will be essential to maximizing the value of your RSUs. 

Prep for the IPO

As a tech professional employed by a pre-IPO company, you need to have a plan for your RSUs. Let’s review the following:

• Understand how many RSUs you have.
• Will you receive single or double-trigger RSUs?
• Learn about the vesting schedule. When are you able to sell your shares?
• Ask about the lock-up period. Are you able to sell your shares when they vest, or do you have to wait?
• Think about your tax burden. Once vested, will you be withholding enough in taxes so that you do not owe more during tax season?
• Evaluate your investment. How much of your net worth is tied up in your company stock? What is your plan for selling or holding your RSUs?

We hope you are getting a firm grasp on stock option considerations for pre-IPO employees. For additional information on RSUs, check out our post on the 5 Biggest Mistakes Tech Employees Make With Their Restricted Stock Units.

Schedule a free strategy session with our team if you still feel overwhelmed or would like some help integrating your stock options into your overall financial plan. We have extensive knowledge of employee stock compensation and would love an opportunity to show you how you could benefit from working with Woven Capital.

Stay tuned next time for our final piece about how to make the most of your options after selling!