Stock options vs RSUs: what do they mean for your total compensation
So first of all if you are reading this I believe that some congratulations are in order. The job that you’ve been offered or the offer that you recently accepted involves some sort of stock in the company as part of your compensation. That’s pretty impressive.
Now let’s help you understand all the lingo and be prepared to ask questions and make informed decisions. We’ll start with the basics.
What are stock options?
When a company gives you stock options what they are doing is providing you with the option to buy a stock at a stated price. The price of the stock is usually stated in the offer letter or your compensation package. You will generally see stock options:
- Used by start-ups as a way to provide incentives without having to use cash
- Granted as a lump sum of options upfront and then doled out over time in the form of a vesting schedule
What are RSUs?
“Restricted Stock Units” (or RSU) are stock shares that a company sets aside specifically for employee compensation. You will generally see RSUs:
- Used by public companies and larger start-ups
- Granted as a lump sum of shares upfront and then doled out over time in the form of a vesting schedule OR
- Paid out as part of a bonus plan
Stock options or RSUs - which is better?
Let’s focus on the facts first.
Stock options are not the same thing as owning the actual stock. Stock option literally means “the option to buy stock,” not the “right to buy” nor the “obligation to buy.” Simply the “option.” This may seem like over-explaining but trust me, it has to be explained.
To get the benefit of owning a stock option, you have to use real money (cash) and purchase the shares of stock.
If you take away nothing else from this article let it be this important point.
Meanwhile, RSUs automatically convert to regular stock at some point and are deposited into a brokerage account in your name. Yes, you will probably need to pay taxes on those shares (we don’t cover taxes in this post but you can find some helpful info here) and you will need to sell those shares to get cash, but they are real shares, in your account, and they are put there without you having to do pretty much anything.
In an apples to apples comparison if you have a choice between RSUs vs stock options for the same company, RSUs are the way to go. Hands down.
Nowadays you will rarely find publicly traded companies offering stock options so if you are staring at an offer letter with options in it then chances are you are considering joining a start-up.
How to value start-up stock options
Stock options are more commonly used by start-ups and smaller companies as part of their equity compensation package. Why? Because start-ups have less cash. Pretty simple. They can’t offer the same cash salaries as large public companies like Facebook and Google for example.
The challenge is that there is, unfortunately, no good way to value what these options are worth and in some cases (sorry to say), they may not be worth anything. On the flip side, there is a small chance that they may be worth more than what you would have earned working at a public company collecting your cash paycheck and stock bonus.
The reality is that it’s a gamble, and the best way to value what stock options at a start-up are worth when considering different equity compensation packages is to value them at $0. Your main considerations should be tied to the actual work you will be doing and the cash salary you will be paid. Do not accept a salary that is too low for you to live on, hoping that your options will be worth some large dollar amount later.
Think of options as a nice perk -- a chance for real upside -- but only a chance.
Details can be overwhelming and every situation is going to be different, but our perspective is that cash is king when it comes to salary compensation and the more of your equity compensation that is paid out in cash the better. We know that not all companies will be able to pay your full market rate in cash or give you the option to choose RSUs vs stock options. And that’s ok, as long as you can cover bills and savings.
We believe that having a financial advisor to guide you through your unique scenario and how it fits into your financial life will help you make an informed decision with an understanding of the tradeoffs you are making.