Tech Stock Compensation Guide: Part 2
This is part 2 of a 2-part series about how you should approach the management of stock compensation. In the first post, I provided an overview of the types of tech stock compensation you could receive. I also provided an in-depth analysis about how I would manage an ISO portfolio.
In this post, I cover RSUs, ESPPs, and long-tail stock instruments.
If you don’t want to read all the way to the end, here’s the TLDR:
- Read the fine print in your stock plan so you don’t accidentally get screwed.
- In most cases, it makes sense to sell ISOs, RSUs, ESPP shares, etc. as soon as they vest.
Compared to ISOs, restricted stock units (RSUs) are much simpler. In large part, this is because RSUs are only offered by large public companies. Big public companies have systems to automate lots of the paperwork for employees. This means that even though RSUS still have vesting cliffs, durations, strike prices, and tax implications, in practice they are much easier to work with.
Understanding RSU Vesting
Just like ISOs, RSUs have a vesting schedule. There seems to be less consistency among RSU vesting details than for ISOs. Some companies let employees start vesting 30 days after starting their role. Others stick to 1-year cliffs. In my time working in big tech, I’ve had monthly (Meta), and yearly (Salesforce, Google) vesting cliffs. I’ve had monthly (Meta), quarterly (Salesforce), and yearly (Google) vesting schedules.
At the end of the day, the pros and cons of these plans boil down to liquidity. If you have a large cash buffer, you won’t care much when your RSUs can be sold. You will be almost entirely indifferent to whether you get the first batch of shares next month or next year.
Most people don’t have that much cash readily available. So, it’s worth it to understand exactly how you’ll get your shares.
Calculating RSU Share Price
When you get an RSU grant, the shares have a specific price. Most of the time, that price is the average of the share price over the month prior to your start date.
For each RSU grant, the issued share price doesn’t change. Because most RSU grants are still issued on 4 year vesting schedules and most big tech companies tend to issue employees large initial grants, the starting share price is very important.
If the company does well, you could end up earning much more than you initially expected. Conversely, if the stock price dips 30%, you may make substantially less than you expected for 4 long years.
RSUs make up a larger fraction of people’s total compensation the more senior they become. As a result, it’s common to see senior execs shifting their start dates back when stock prices are particularly volatile. By switching their start dates, they can lock in more favorable initial share prices.
Most companies stop giving employees RSUs the moment they leave. You could hold onto shares, of course, but that’s the same as owning shares of a particular company’s stock.
This simplifies the process of getting the shares in the first place. It also makes a stronger case for selling your RSUs as soon as they vest. More on that below.
RSU Tax Benefits
The issued value of an RSU has no tax advantages like ISOs. If you get 100 shares at $50 per share, all $5,000 of that value is taxable as regular W2 income.
If you hold onto the RSU for at least 1 year, any price appreciation will be taxed as long-term capital gains. Losses can be claim and carried forward too. However, in my experience, losses and gains on RSUs tend to be pretty small, so the tax advantages have never been worth optimizing for.
The real tax advantage of RSUs is that most companies that issue them automatically deduct income taxes for you. Your brokerage withholds some of the proceeds for you automatically whenever you sell shares. That means that you don’t need to keep a huge cash buffer for tax season.
The OverthingMoney Approach to RSU Tech Stock Compensation
Managing income from an RSU plan is much easier than ISOs. So, I have only 1 rule when it comes to RSUs: sell the shares as soon as they become available.
The reasons I advocate for this are the same as for ISOs. First, you should always seek diversification. Second, insider trading laws make it hard to trade your company’s stock.
You only receive RSUs when you are actively working for the company. So, the need for diversification is even more extreme than for ISOs. Startup ISOs can be exercises after you quit. You could work for a startup, quit, and then exercise your shares while working for another company. In that case, you would have two sources of income: ISOs from company A plus salary from company B.
Having income from two sources is much lower risk than just one. You are already long on the future of your employer by working there. Don’t put all your eggs in a single basket! As soon as RSU shares vest, sell them! Reinvest the money in another more diversified asset like an index or mutual fund.
Don’t Go to Jail
The Securities and Exchange Commission (SEC) prohibits employees working at companies from trading their company’s stock when they are in possession of material information about the company’s future performance.
At a theoretical level, you could make the case that any employee working at a company has “material” information. In practice, however, the courts tend to define “material” as very significant indeed. An upcoming acquisition announcement, earnings miss, or key executive departure would all probably meet the standard for “material knowledge.”
Most material information is only available to execs. I’m not an SVP, so why do I think it’s risky to actively trade your own company’s stock? It boils down to a simple risk assessment. If you are indicted for securities fraud, that will make you a felon. It’s hard to find work as a felon. You may be more risk-tolerant than me, but I think that taking even a .01% risk of becoming a felon makes no sense.
Avoid Active Trading
Maybe you hate diversification. Or maybe you just don’t buy my insider trading risk aversion. That’s fine, but I still think there’s strong evidence that just holding your company’s stock doesn’t make sense.
ESPPs and Everything Else
What if your tech stock compensation isn’t in the form of ISOs or RSUs? My recommendations still hold for other types of stock-based compensation: sell early and often where possible. For ESPPs in particular, I think the primary risk is that you buy and hold the stock long-term instead of selling it and diversifying.
Would You Buy Your Company’s Stock?
Before I worked at Salesforce, I had never independently purchased Salesforce stock for myself. If you find yourself in that situation, you should question the value of holding the stock as an employee.
Most of the Salesforce employees I knew that held the stock weren’t investing in the company’s stock outside of their compensation plan. They got the company’s stock and just held onto it because it was easy.
If you think that makes sense, think of it another way. Let’s say you get an email one day from an investment manager. He wants you to invest in his fund, which he assures you has excellent yearly returns. When you ask how he picks his assets, he tells you “I got some stock a while back and I’m holding it because I don’t want to figure out the brokerage interface for making trades.”
Would you give him your money? Neither would I. That’s essentially what employees are doing when they hold their employer’s stock.
Hopefully this guide has been useful as a way to think about how you manage your stock compensation. Here’s a quick TLDR summary as I wrap up:
- Read the fine print in your stock plan to ensure that you don’t get accidentally screwed.
- In most cases, it makes sense to sell ISOs, RSUs, ESPP shares, and other more exotic company shares as soon as they vest.
If you can, look into ways that you can automate selling your shares. For ISOs, there isn’t an easy way to do this. For RSUs and ESPPs, however, your employer may offer a way to automatically buy/sell. I just signed up for Google’s version of this plan. It’s great not having to login and fiddle with Charles Schwab interfaces once a month.
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