Restricted Stock Units

A Restricted Stock Unit (also known as an RSU) is a form of compensation issued by an employer to an employee in the form of company shares. Think of it as a promise from your company to give you shares of its stock at a future date, provided you meet certain conditions. This “promise” is the key difference from a direct stock grant; you don't actually own the shares from day one. Instead, you are granted the right to acquire them after a predetermined period, a process known as vesting. The most common condition for vesting is simply continuing to work for the company for a set amount of time. Once vested, the RSUs are converted into shares of common stock, and they become yours to keep or sell. Unlike stock options, which can become worthless if the stock price falls, RSUs almost always retain some value as long as the company's shares are trading above zero, making them a popular and less risky way for companies to give employees a stake in the business.

The life of an RSU follows a simple, three-step journey from promise to ownership. Understanding this timeline is crucial for any employee receiving them.

This is day one. The company formally grants you a specific number of RSUs. The grant agreement will detail everything you need to know, including how many units you've been awarded and, most importantly, the vesting schedule. At this point, the RSUs have no tangible value to you. You can't sell them, and they aren't taxed. It's simply a documented promise.

Vesting is the waiting game—the period you must fulfill certain conditions (usually tenure) before the shares are truly yours. It’s like putting a cake in the oven; you have to wait for it to bake before you can eat it. There are two common types of schedules:

• Cliff Vesting: All your shares vest at once after a specific period. For example, 100% of your RSUs might vest after you complete one year of service. If you leave before that one-year “cliff,” you get nothing.
• Graded Vesting: Your shares vest in increments over time. A very common schedule is vesting over four years with a one-year cliff. For example, 25% of your shares vest on your first anniversary, and the remaining 75% vest in smaller chunks (e.g., monthly or quarterly) over the next three years.

This is the payday. When a portion of your RSUs vests, they are “settled” or “delivered” to you as actual shares of stock. This is a taxable event. The market value of the shares on the vesting date is considered ordinary income, just like your salary, and you will owe income tax on that amount. Companies typically handle this by automatically withholding a portion of the vested shares to cover the estimated taxes, delivering the “net” number of shares to your brokerage account.

While both are forms of equity compensation, RSUs and stock options function very differently. For an employee, the distinction is critical.

• What You Get:
  • RSUs: You are given the full value of the shares upon vesting. If 100 shares vest when the stock price is $50, you receive $5,000 worth of stock (before tax).
  • Stock Options: You are given the right to buy shares at a predetermined strike price. If your strike price is $30 and the stock is trading at $50, you can buy a share for $30 and realize a $20 gain.
• The Risk Profile:
  • RSUs: They are valuable as long as the stock price is above $0. Their value goes up and down with the stock, but it rarely disappears entirely.
  • Stock Options: They are only valuable if the stock's market price is higher than the strike price. If the stock price falls below the strike price, the options are “underwater” and worthless. This makes them much riskier but also offers greater leverage if the stock price soars.

In short, RSUs offer more certainty, while stock options offer more potential upside (and downside).

Whether you are an employee receiving RSUs or an outside investor analyzing a company that issues them, a value investing mindset provides a powerful lens for making smart decisions.

Receiving a large grant of RSUs can feel like hitting the jackpot, but it introduces significant risks that must be managed.

• Concentration Risk: As your RSUs vest, you can quickly find that a huge percentage of your net worth is tied up in a single stock. This is the opposite of diversification and is incredibly risky. No matter how much you believe in your company, a single unforeseen event could severely damage your financial standing.
• The Endowment Effect: People tend to overvalue things they own. Because you “earned” these shares, you may feel an emotional attachment that prevents you from selling, even when it's the logical move. To fight this bias, ask yourself a simple question: If my company paid me a cash bonus equal to the value of my vested shares, would I use 100% of that cash to buy company stock today? If the answer is no, you should strongly consider selling a significant portion of your vested shares and reinvesting the proceeds in a diversified portfolio. Treat vested RSUs like a cash bonus, not like a family heirloom.

Value investors must look past the accounting tricks and understand the real economic impact of RSUs on a business.

• Dilution: When a company issues millions of new shares to satisfy RSU grants, it dilutes the ownership stake of existing shareholders. Your slice of the company's earnings pie gets smaller. A company that relies heavily on equity compensation is constantly transferring value from its owners (shareholders) to its employees.
• Stock-Based Compensation is a Real Expense: Many companies, especially in tech, report “adjusted” or “non-GAAP” earnings that add back stock-based compensation (SBC), making profits seem larger than they are. A shrewd investor must reject this. As Warren Buffett has argued, SBC is a very real expense. It is a non-cash expense on the income statement, but it's a real cost to shareholders. To get a true sense of a company's profitability, you should always check the financial statements (specifically the cash flow statement) for the amount of SBC and mentally (or literally) subtract it from the reported earnings to calculate a more conservative version of free cash flow. A company's ability to generate cash after all expenses—including what it pays its people in stock—is what determines its long-term value.