The merits of Stock Options vs Restricted Stock Units (RSUs) primarily depends on the stage of the company. Stock Options are usually better for both employee and employer at an early stage company. For a later stage company, RSUs are usually better for both.

The fundamental difference is that a Stock Option allows the optionee to purchase stock after vesting while a Restricted Stock Unit is a promise to deliver a share of stock at vesting.

This difference translates to potentially superior tax treatment for stock options because an opportunity to invest exists whereas RSUs are characterized as deferred compensation. Read more on the tax implications of stock options.

Below we will walk through the differences between stock options and RSUs, as well as the pros and cons of each.

What is a Stock Option?

A stock option gives you the right to buy company shares at a fixed price called the strike price. That price is set at the time of your grant, based on the company's Fair Market Value (FMV). If the company grows and its FMV rises above your strike price, your options become increasingly valuable. You don't own anything until you exercise; you hold a contractual right to buy. Options are most common at early-stage startups where potential upside is high but liquidity is years away.

What are Restricted Stock Units (RSUs)?

A Restricted Stock Unit (RSU) is a promise to deliver a share of company stock when vesting conditions are met, with no purchase required. Unlike options, RSUs are never underwater because there is no strike price; they always have value as long as the stock does. They are taxed as ordinary income when they vest (or at a liquidity event for double-trigger RSUs), which means the tax bill arrives whether or not you have sold.

Most private companies grant RSUs with double-trigger vesting: shares only convert and become taxable when both a time-based condition (your vesting schedule) and a liquidity event (IPO or acquisition) occur. This protects employees from owing income tax on shares they cannot yet sell. At public companies, double-trigger is not necessary because shares are freely tradable when they vest, so the tax event is straightforward.

Stock Options vs RSUs

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ISOs vs. NSOs: what type of stock option do you have?

Not all stock options are taxed the same. The two main types, Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs), have meaningfully different tax treatment. See the full ISO vs. NSO comparison →

Which Is Better: RSUs or Stock Options?

Neither RSUs nor stock options are universally better. The right answer depends on your company stage, tax situation, and risk tolerance. Most of the time you will not have a choice: your company will either offer you options or RSUs.

• RSUs are generally better when: the company is public/stable, you want lower risk, you prefer simplicity
• Stock options are generally better when: the company is early-stage, there is significant upside potential, you can handle the tax complexity

Pre-IPO sales:

• Stock options can be turned into shares that can be sold while the company is still private. This usually requires permission.
• RSUs cannot be transferred at all.
  • ESO Fund however does offer Liquidity For RSUs.

Long Term Capital Gains treatment:

• A stock option can be exercised at almost any time to qualify for reduced taxes via LTCG (or no taxes through Qualified Small Business Stock).
• However, exercising can trigger a lot of tax. Small blocks of ISOs can avoid AMT but this benefit is limited by the $100K Limit Rule. NSOs are always subject to immediate withholding tax upon exercise.
• An RSU must be held for a year beyond vesting to qualify for LTCG when sold. Typically that means one year post-IPO for "double trigger" RSUs.
• Even after the IPO, a stock option can be retained while still appreciating in value and deferring taxes. On the other hand, an IPO triggers ordinary income taxes for RSUs.

How stock options and RSUs affect you as an employee

• A stock option can be underwater and worthless if the FMV is below the exercise price. An RSU is never underwater because there is no strike price.
• Stock options exercised and held for the required period qualify for lower long-term capital gains rates. RSUs vest as ordinary income regardless of how long you hold them afterward.
• The strike price and associated taxes of stock options act as a retention mechanism. Even when exercised early, having skin in the game better aligns employee and company interests.
• RSUs lack the retention benefits of options. Employees can quit after a year without the financial tie inherent to options, which can dilute the option pool for future employees.
• Rapidly rising FMVs are bad for employee taxes. Companies are motivated to slow the growth of the 409A while issuing options. As the FMV rises, the high exercise price of stock options becomes less attractive for new hires.
• Most late-stage companies turn to RSUs, and during the RSU phase, companies are motivated to have the FMV rise.
• There is no exercise price for RSUs. Employees receive the full value of a stock equivalent for free. As such, an RSU is never underwater.
• Companies have a clear sense for how to grant fairly between employees arriving at different times. A particular job title might be budgeted for $100k in RSUs; the number of RSUs to grant is simply $100k divided by the current FMV.
• RSUs typically expire within 5 to 7 years and companies are not obligated to reissue them.
• When employees turn in shares to cover taxes for RSU vesting, the company still has to send real money to the IRS as opposed to shares. This is a very poor use of IPO share selling proceeds that usually has to be disclosed in the IPO prospectus.
• If an employee exercises, the company gets cash. If the employee pays taxes on options, the company gets a tax deduction.
• Until an optionee finally recognizes the income tax on a stock option, the company does so instead. Companies concerned with their reported earnings per share won't like the volatility of their stock price affecting their earnings report.

What happens to your stock options when you leave a company?

When you leave a startup, your vested ISOs typically expire in 90 days. Miss that window and they're gone, regardless of how much they're worth. The cost barrier is real: you'd need to cover the strike price plus any AMT, often tens of thousands of dollars, on shares you can't yet sell.

That's exactly the problem ESO Fund was built to solve. We cover 100% of the exercise cost and taxes, and if the company never exits, you owe us nothing. Most clients are funded within 1-2 weeks. See how ESO Fund works →

For more information on how to monetize your private company equity, please contact us at the Employee Stock Option Fund.

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Written by Jordan Long, Marketing Lead at ESO Fund