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RSUs in an EXECUTIVE EMPLOYMENT AGREEMENT

Experienced legal representation in reviewing, negotiating, drafting, improving executive employment agreements.

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Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

Restricted Stock Units (RSUs) are a form of equity-based compensation, whereby the corporate employer grants the executive shares of its stock (or a cash payment equal to the value of the stock) at a future date, provided certain conditions are met. The grant of the RSU forms part of the compensation set out in the executive employment agreement, with the RSUs representing an outright grant of stock once the conditions are satisfied.

The key characteristics of restriced stock units include:

  • Vesting: The RSU grant is subject to a "vesting schedule." This is a timeline or a set of conditions that must be fulfilled before the employee gains ownership of the shares.

    • Time-Based Vesting: The most common type, where a certain percentage of the RSUs vest after a specific period of time (e.g., 25% after one year, with the rest vesting monthly or quarterly over the next three years).

    • Performance-Based Vesting: Vesting is tied to the achievement of specific company or individual performance goals (e.g., reaching a certain revenue target, or a successful IPO).

    • Double-Trigger Vesting: This requires both a time-based condition and a performance-based condition to be met, often used by private companies where the performance trigger is a liquidity event like an IPO or acquisition.

  • No Ownership Rights Until Vesting: The recipient of an RSU is not a shareholder until the units vest and the shares are issued. This means they do not have voting rights or receive dividends on the unvested RSUs. Some companies may offer "dividend equivalents" to compensate for this.

  • Taxation: RSUs are generally taxed as ordinary income at the time of vesting. The taxable amount is the fair market value of the shares at that time. A portion of the shares is often sold to "cover" the taxes, with the remaining shares transferred to the employee. Any future appreciation in value is subject to capital gains tax when the shares are sold.

RSUs can be a significant component of an executive's compensation, with corporate employers using the inclusion of RSUs to attract and retain top executive talent, as they align the executive's interests with the long-term success of the corporation. Focal points for negotiation of RSUs in the executive employment agreement, included:

  • Vesting Schedule: This is a primary point of negotiation. While a standard 4-year vesting schedule with a 1-year "cliff" is common, executives may negotiate for a shorter vesting period, more rapid vesting, or accelerated vesting under specific circumstances (e.g., termination without cause, or a change in control of the company).

  • Size of the Grant: The number of RSUs granted is a critical factor. The value of this grant is often a significant portion of an executive's total compensation, especially at later-stage or public companies. Executives may negotiate for a larger initial grant, or for subsequent grants tied to performance milestones.

  • Termination and Severance: It is crucial to define what happens to unvested RSUs upon termination. A well-negotiated agreement should specify that an executive keeps any fully vested shares. For unvested shares, the agreement should address:

    • Pro-rata vesting: Whether the executive will receive a portion of the unvested units based on their time of service in the current vesting period.

    • Accelerated vesting: If a "without cause" termination or a "change in control" event occurs, the agreement may provide for accelerated vesting of all or a portion of the unvested RSUs. This is a common and important provision for executives.

  • Clawback Provisions: These are clauses that allow the company to reclaim incentive-based compensation (including RSUs) under certain circumstances, such as a financial restatement due to executive misconduct. Understanding and negotiating the terms of these provisions is essential.

  • Tax Considerations: Executives should work with a financial advisor and tax professional to understand the tax implications of their RSU grants. This includes planning for the income tax liability at vesting and the potential for capital gains taxes on sale. The agreement itself can sometimes include a "sell-to-cover" clause to automatically manage tax withholding.

  • Private vs. Public Companies: The nature of the RSU grant can differ between private and public companies. In private companies, a "double-trigger" vesting schedule is often used to defer the taxable event until a liquidity event (like an IPO or acquisition) provides a way for the executive to sell shares and cover the tax liability. For public companies, RSUs are typically time-based and vest more predictably.

Executive employment agreements deserve considerable scrutiny and legal analysis given the financial implications emanating from the legal employment contract not being consistent with the negotiated specifics of one's intended employment arrangement. The differences in executive employment agreements may not be readily apparent to most people (often being very subtle and driven by legal terminology), yet the long-term financial implications to the executive employee can be staggering. As such, it is important to properly understand all the contractual aspects pertaining to an executive employment and their compensation.

For knowledgeable and experienced legal representation with respect to executive employment agreements, and other legal matters pertaining to one's employment as an executive employee, contact our law firm by email at Chris@NeufeldLegal.com or by telephone at 403-400-4092 / 905-616-8864.

 

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