The Human Capitalist Series P.7: When Would A Company Use Stock Awards Instead of Stock Options?

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The Human Capitalist Series P.7: When Would A Company Use Stock Awards Instead of Stock Options?

We often are asked when a company would use “full value” stock awards (stock purchase, stock bonus, or RSUs) rather than stock options. There are a few scenarios in which stock awards might be a more beneficial method of equity incentive than stock options:

  • Very early-stage company with de minimis fair market value per share. Stock bonus awards (including unvested grants subject to forfeiture) make a lot of sense when the fair market value of the company’s common stock is very low, and therefore the tax bill at grant (assuming an Internal Revenue Code Section 83(b) election is made) is affordable.
  • Late-stage company where the fair market value of the common stock is approaching public-company levels and a liquidity event is near. RSUs are sometimes used by later-stage private companies that are competing for talent with both public companies (which offer RSUs with liquid stock) and startups (which offer cheaply priced stock and significant upside). However, given the tight timing for tax withholding, most companies try to avoid using these awards unless an exit is within 12-18 months or is more than 5-7 years away. However, for a company anticipating continuing stock price increases (especially if the stock price is lower now than a year ago due to broader issues in the economy), RSUs may not offer the same opportunity for leverage (and therefore exit value) as stock options.
  • RSUs may help near-term pre-IPO companies avoid or minimize “cheap stock” charges. Granting RSUs instead of stock options in the 12- to 18-month period before the IPO may help a company minimize the “cheap stock” charges associated with granting equity compensation close to the IPO.
  • RSUs may help pre-IPO companies limit the number of stockholders and secondary trading. If RSUs are granted by a pre-IPO company with a liquidity event vesting condition, the shares underlying the award will not be issued, and the grant recipients will not become stockholders, prior to the liquidity event. However, employees may see this as a detriment and so this may make the RSUs a less effective incentive. Employee stock ownership issues (arising following exercises of options) may be managed through voting proxies and rules on access to books and records.