Understanding Double Trigger RSUs

 

In this blog post, we'll unpack the meteoric rise of double-trigger RSUs and why they now eclipse other equity awards like stock options. You'll learn how the clear vesting schedules, favorable tax treatment, and flexibility of RSUs provide advantages for both employers and employees.

Equity compensation has become essential for attracting and retaining top talent, especially in competitive industries like technology. As companies grant more equity, understanding the nuances between different types of awards is critical. Restricted stock units (RSUs) have emerged as the most popular form of equity compensation in the last decade, especially double-trigger RSUs. But why have double-trigger RSUs become so dominant?

 

Understanding RSUs

RSUs are company stock given to employees as part of their compensation package, typically with the aim of aligning the employee's interests with those of the company and promoting long-term commitment.

They are granted with specific conditions, such as vesting schedules, which must be met before the RSUs can be converted into actual shares of the company stock.

This vesting of RSUs adds an element of delayed gratification, encouraging employees to remain committed to the company's success.

The RSU structure often includes a time-based vesting schedule, where RSUs become available to the employee after they have worked at the company for a certain period.

Alternatively, performance-based goals can be set, requiring the employee to meet specific targets before the RSUs are granted.

It's important for RSU holders to stay informed about the particular vesting schedule and any conditions associated with their RSUs in order to maximize their potential financial gains.

Equity compensation like RSUs can be a boon for professionals working at startups or established companies. For a company in its early stages, offering RSUs is a way to attract and retain talent without straining its financial resources.

As an RSU holder, participating in an RSU program allows you to financially benefit from the company's growth, which can lead to a significant wealth increase if the company fares well in the market.

Double-trigger Restricted Stock Units (RSUs) are a form of equity compensation that requires two specific events to occur in order for the RSUs to vest.

The two events (or triggers) that typically occur when dealing with double-trigger RSUs are a change of control event (such as a company merger or acquisition) and an involuntary termination or loss of employment (i.e., being laid off).

The thinking behind this double-trigger RSU design is to provide additional protection to employees who may experience job loss.

Let's delve into how double-trigger RSUs work.

  • The first trigger event is typically the change of control event. This event, which could include a company being acquired or going public, causes the RSU to become eligible for vesting.

  • The second trigger event, the involuntary termination of employment, is necessary for the double-trigger RSU to fully vest. Until both triggers occur, the RSUs remain in a state of potential vesting.

So, what are the benefits of double-trigger RSUs? Well, for one, they align the interests of employees and shareholders by motivating employees to work towards favorable corporate events.

This incentive can boost morale and encourage employee retention.

On the other hand, double-trigger RSUs provide protection to employees who might lose their jobs due to circumstances beyond their control.

Tax Implications of Double Trigger RSUs

When it comes to Double Trigger RSUs, taxation comes into play upon vesting. Keep in mind that vesting is contingent on two conditions being met, hence the "Double Trigger" name.

Generally, these conditions involve a specific performance milestone and a change in control event.

Upon vesting, the RSUs are taxed as ordinary income.

The amount taxable will be based on the market value of the shares at the time of vesting.

An important aspect we need to address regarding the income tax liability on Double Trigger RSUs is the tax withholding method. Employers often withhold an appropriate amount of shares to cover the tax obligation or allow the employee to pay the taxes separately.

After the vesting event, the RSUs turn into actual shares which might be subject to capital gains tax if the employee holds onto them and they appreciate in value.

The calculation of capital gains tax depends on the length of time the shares are held and the difference between their market value when sold and the value at the time of vesting.

Vesting and Trigger Scenarios for Double Trigger RSUs

Double trigger RSUs require two conditions to be met before they can vest.

The first is often a service-based or time-based vesting schedule. This means employees need to remain with the company for a certain duration, typically three or four years, before their RSUs begin to vest.

The second vesting condition is the occurrence of a liquidity event, such as a change in control (CIC) or the company going public. In a double trigger RSU scenario, the vesting event occurs when both the service-based vesting condition and the liquidity event coincide.

For example, if an employee has a four-year vesting schedule and a CIC occurs three years after their start date, only 75% of the RSUs will vest.

It's crucial to understand that RSUs may also be subject to performance-based vesting conditions, linked to company or individual performance goals.

Here are two scenarios illustrating how double-trigger RSUs work:

Scenario 1: Startup Acquisition

Scenario 2: Going Public

 

Employee: Jane, a Software Engineer
Company: TechStart, a growing startup
Service-based Vesting Schedule: 4 years
Liquidity Event: Acquisition by a larger tech company

 

Timeline:

  • Year 1: Jane joins TechStart and is granted RSUs with a 4-year vesting schedule.

  • Year 3: TechStart is acquired by a larger tech company. This triggers the liquidity event condition.

 

Outcome:

  • Jane has been with the company for 3 years, so 75% of her RSUs have met the service-based vesting condition.

  • The acquisition triggers the liquidity event condition.

  • Both conditions are met, so 75% of Jane's RSUs vest immediately upon the acquisition.

Employee: Mark, a Data Scientist
Company: DataCorp, a tech company specializing in big data
Service-based Vesting Schedule: 4 years
Performance-based Vesting: Company must reach a revenue milestone
Liquidity Event: Company goes public (IPO)

Timeline:

  • Year 1: Mark joins DataCorp and is granted RSUs with a 4-year vesting schedule and a performance-based condition tied to company revenue.

  • Year 2: DataCorp reaches the revenue milestone, fulfilling the performance-based condition for Mark.

  • Year 4: DataCorp goes public, triggering the liquidity event condition.

Outcome:

  • Mark has been with the company for 4 years, so 100% of his RSUs have met the service-based vesting condition.

  • The performance-based condition was met in Year 2.

  • The IPO triggers the liquidity event condition.

  • All conditions are met, so 100% of Mark's RSUs vest immediately upon the IPO.

 

Double Trigger RSUs vs. Single Trigger RSUs

Let's dive into the somewhat fraught question of single-trigger RSUs versus double-trigger RSUs.

Single-trigger RSUs typically vest over a predetermined period, such as 4 years, and the recipient becomes entitled to the shares once the vesting conditions are met.

On the other hand, RSUs with double-trigger vesting require the fulfillment of two separate conditions or "triggers" for the shares to be granted. The first trigger in double-trigger RSUs is often the same as that of single-trigger RSUs – continued employment with the company.

However, the second trigger is typically tied to a significant event, such as a company sale or achieving specific performance milestones.

In terms of advantages, double-trigger RSUs can provide a more direct alignment of employee interests with the company's long-term success.

On the flip side, employees may feel more uncertainty due to the additional trigger condition, and the shares might not ever vest if the company doesn't reach the required milestone.

Single-trigger RSUs provide a straightforward vesting schedule with more predictability for employees. However, they might not offer the same level of motivation to achieve performance targets as double-trigger RSUs do.

Conclusion

Understanding the intricacies of RSUs, especially double-trigger RSUs, can be a complex endeavor. These financial instruments offer a unique blend of incentives and protections for employees, aligning their interests closely with the company's long-term goals. However, the tax implications and vesting conditions can be challenging to navigate without expert advice.

If you're grappling with the complexities of RSUs and how they fit into your financial planning, don't go it alone. At BKFis, we specialize in helping both individuals and companies make the most of their equity compensation packages. Contact us today for a consultation, and let us help you unlock the full potential of your RSUs.






AJ Grossan