In this post, you'll find everything you need to know about Restricted Stock Awards (RSA):
How RSAs work
Tax considerations
Pros
Cons
The term Restricted Stock Awards (RSA) originated in Silicon Valley as the name for a key element of its venture-building playbook. In Norwegian, RSA can be translated as “restricted shares” or “shares subject to restrictions.” For simplicity, we will use the term RSA throughout.
RSA is a popular way to incentivize a company’s first employees, particularly in the very early stages of its lifecycle. With an RSA, employees receive shares in the company. This can allow the company to keep cash compensation at a lower level during a phase when cash is often a scarce resource.
The agreement under which the employee receives the shares includes certain restrictions. For example, it is common for employees to earn the right to retain their shares over time, meaning that if they leave the company, they may have to return any shares they have not yet earned. This can motivate employees to contribute to the company’s growth over the long term.
An RSA can therefore be compared to an investment in the company, where the investor is an employee who has the opportunity to acquire shares early and at an attractive price. On the other hand, the employee must return any unearned shares if they leave the company early or fail to meet other criteria required to retain them.
This helps protect the company and prevents what is often referred to as “dead equity” and a “broken” cap table. Dead equity can create frustration among active shareholders and make the company a less attractive investment opportunity.
How do RSAs work? 🤝
When an employee is granted (offered) a Restricted Stock Award, they must decide whether to accept or decline the offer.
In principle, the shares can be granted free of charge, but they are usually offered at a price. Since this instrument is most commonly used in the early stages of a company, the price can be very attractive. It is also possible to use an RSA model in more mature companies if it is structured using a convertible arrangement. Such convertible structures are covered in a separate blog post.
After accepting the offer and, where applicable, paying for the shares, the employee must wait for a certain period before the restrictions are lifted. The period during which the shares are subject to restrictions is commonly referred to as the vesting period.
There are two main types of vesting: time-based vesting and milestone-based vesting. For early-stage companies, time-based vesting is the most common.
With time-based vesting, the shares typically vest gradually throughout the vesting period. If the employee leaves before the end of the vesting period, the company has the right to repurchase the unvested shares at the same price the employee originally paid for them.
Let’s illustrate this with an example:
An employee receives an RSA with a four-year vesting period, with shares vesting each quarter gradually. The employee must therefore remain with the company for four years to earn the right to retain all the shares.
If the employee leaves the company after one year, they are entitled to retain the shares that have vested (1/4 of the shares granted). The graph below also shows that the plan has a 12-month cliff, meaning that no shares vest until the employee has completed the first 12 months.
Tax considerations 🧾
If the RSA is granted free of charge, this is considered a benefit derived from employment, and the employee is taxed as though the value of the shares had been received as salary.
If the employee pays less than market value for the shares, the discount is considered a benefit derived from employment, and the employee is taxed as though the value of the discount had been received as salary.
If the shares are purchased at market value, no employment income tax is triggered for the employee.
Any gain from the subsequent sale of the shares is taxed as capital income, usually at a lower rate than employment income.
Tax on gains from the sale of shares may fall under the Norwegian participation exemption method (fritaksmetoden) if the employee owns the shares through a holding company. However, ownership through a holding company does not affect any taxation of employment income.
For companies only: If the RSA is granted free of charge or at a discount and this is treated as employment income for the employee, the company is required to pay employer’s National Insurance contributions where applicable.
Pros of RSAs 👍
The employee becomes a shareholder: The employee receives and owns the shares from the grant date (day one), which may include voting rights at general meetings and the right to receive dividends.
Lower tax: If the shares are purchased while their value is still low, the total tax liability may be lower than when using stock options.
Greater potential upside: Since the employee becomes a shareholder at an early stage, the potential upside can be greater.
Deferred taxation: If the shares are purchased at market value, no tax liability arises until a potential gain is realised.
Cons of RSAs 👎
Immediate payment: If the shares are purchased at market value, the employee must pay for them on the grant date.
Tax: If the shares are granted free of charge or purchased at a discounted price, the discount is treated as employment income for the employee. The company must also pay employer’s National Insurance contributions. Because of the restrictions on the shares, the employee may not be able to sell them to cover the resulting tax liability.
Risk: The employee risks losing the amount paid for the shares.
Two types of "restricted stock"
Restricted Stock Awards (RSA) should not be confused with Restricted Stock Units (RSU).
The difference is that an RSU is a promise to receive shares in the future (after vesting) at no cost. Specific tax considerations apply in such cases. You can read more about Restricted Stock Units in this post.
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