Stock Options or RSUs?


#1

Some companies grant employees one or the other. My sister is working at a company that lets her choose stock options or RSUs. Every November, all employees must choose their allocation. She’s is granted $25k worth of stock every year. Her company is in the Health Care / Surgical Supply industry. It’s still growing and offers specialty surgery products. She plans on staying at least 10 more years.

Her options are as follows:

  1. 100% Stock Options
  2. 25% Stock Options and 75% RSUs
  3. 50% Stock Options and 50% RSUs
  4. 75% Stock Options and 25% RSUs
  5. 100% RSUs

Here’s the rub. The two options are not equal. The company gives stock options at 1-1, but RSUs are 3-1. By this I mean she can choose (1 stock option or .33 RSU). For ease of calculation, her $25k could buy her 1000 stock options or 333 RSUs. So the initial face value of the option is much more, but so to is the risk of not making money on the stock options.

Last night over too many bottles of wine, the two of us went back and forth over which option is best. I figured I’d toss the question out to all of you. What would you do and why?


#2

When you say she could use her $25K to buy 1000 stock options, what do you mean? Are her options issued to her at an in the money strike price? I would have thought the options would be granted with a strike price at FMV, so she’d have no upfront payment (but then, that’s not the same as getting $25K worth of stock), whereas on the RSUs, she’d have to pay for them upfront (unless the Company offers to loan her part of the money to pay for the RSUs?). I think we need a few more details to be able to answer the question.


#3

Also, are the vesting terms the same between the stock options and the RSUs?


#4

Good questions. RSUs vest over 4-years, 25% each year. Stock options have a 10-year expiration. They can be cashed in anytime after 1 year.

The 1,000 share mention is an example. I was trying to illustrate the difference between the two options. A better way of saying it is if stock options gave her 1,000 shares of X, RSUs would only giver her 333 shares of X.


#5

Sure, I get that 1,000 is an example. So let’s keep running with it.

If she goes the stock option route she gets 1,000 stock options in exchange for no cash and the strike price is FMV? In other words, if she were to exercise the stock options on day 1 (which I know she can’t do, I’m just using it as an example), she’d own 1,000 stock but she would have paid full price for the stock?

And on the RSUs, she has the ability to get 333 shares. Does she have to pay for them? Or are they granted to her?

Just trying to set the parameters. If she’s given the 1,000 stock options, they could go up in value over time (and she’s 3X as leveraged), but they could also go underwater and be worthless. If she’s granted the 333 RSUs, then her upside is capped at 1/3 of what she could have received if she had taken the options, but she’s getting real value today because she can always sell the stock even if it slides in value 20% (in contrast to the options, which are worth nothing if they are underwater or if the price of the shares stay flat).


#6

Wow. I can’t believe they ask employees to do this.

Mathematically, the correct answer is to calculate the value via black-scholes model and then compare it with the value of the RSU.

My company just gives us 50/50%, and the stock options have significantly over-performed the RSU, but our stock prices have increased.

I’d just choose 50/50 and see how it goes.


#7

I’m not sure if it’s that easy. The Black Scholes value won’t be taxed as income, but the granted RSUs will be. It’s also rare in my experience to see the employees given a choice which is why I’m following along!


#8

Sorry, I left too much info out. You’re on the right track. Both are granted, of course an option is just that, while the RSUs are actual stock. Both are granted at current market value. Stock options can be cashed in anytime after 1-year. RSUs vest over 4-years at a rate of 25% a year.

In our discussion, we were weighing out the best or choice given a level of safety.


#9

It’s also whether or not you believe the underlying stock will go up. RSUs are nice but nothing beats deep in the money stock options when stock prices rise significantly.


#10

I recently had to make a similar decision. After closing a deal to sell 39% of our company to Private Equity, I was given the option to choose 6,000 stock options or 6,000 shares of stock. Most were not given the option, the majority got stock options, and a few were offered stock.

With the options there was no out of pocket expense and the strike price was set at the current market price, based on an official valuation. Any gains by going this route would be taxed at ordinary income tax rates, which for me in California would mean at least 12.3% state tax and 39.6% federal tax, and 3.8% federal net investment income tax (thanks Obama Care). So gains would be taxed at ~55.7% (taxes are just an estimate).

With the stock, I would be required to contribute 35% of the value, and the company would loan the remaining 65% at a 1% interest rate (that would just be deducted from the proceeds during next liquidity event). In this case the 6,000 shares were worth $50/share or $300,000. Therefore I would have to put $105,000 of my own money in the game. The benefit would be the gains would be taxed at long term capital gains rates. This would equate to a 20% tax rate federally (based on our income bracket) and 12.3% for state taxes (~32.3%).

I chose to go the equity route and cut a check for $105,000 in return for much lower taxes on future gains. Of course I took on risk as a trade off, however the loan from the company is non-recourse, so no risk beyond my initial capital contribution.

Options or Stock both vest over 4 years at 25% per year.