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Context: Restricted stock units (RSUs) are a form of equity-based incentive compensation awarded to employees. They allow corporates to delay dilution caused by issuing stock until a vesting period is complete, often linked to the employee’s performance or their time at the company. Like with other forms of compensation, RSUs require the employer to withhold payroll taxes, in this case when the shares are delivered to the employee.
Picking a method. The treasurer of one NeuGroup member technology company explained to NeuGroup Insights the tax withholding decision facing companies that issue RSUs: “You have a choice as to how you want to fund the payroll taxes. Assume an employee is getting 100 shares and that the tax rate is 40%:
- “Sell to cover. This means that you deliver 60 shares to the employee and you sell the other 40 shares in the open market to raise funds for the payment. If you have a lot of stock awards being issued at the same time, this can add a lot of selling activity in your stock on one day.
- “Net share settlement. This means you deliver 60 shares to the employee and fund the tax payment out of corporate cash. This means you don’t have to issue equity to fund a tax payment and you don’t have the selling pressure on your stock like in sell to cover. The downside of this is that it uses up cash.”
That downside means companies that want to conserve cash may prefer to use sell to cover, a point made by Deloitte in 2020 amid the economic downturn sparked by the pandemic: “Companies that currently utilize net share settlement procedures for equity award tax withholding and have a need for additional cash could consider shifting to a ‘sell to cover’ arrangement whereby some of the stock underlying the equity award is sold to cover the withholding tax. Such a change would obviate the need for the company to use its own cash to satisfy the tax withholding obligations.”
Member question: “For employee RSUs, have other members recently considered switching from net share settlement to sell to cover?
- “We partner with Shareworks [owned by Morgan Stanley] and are evaluating switching from net share settlement (withholding a portion of shares for taxes) to sell to cover (at vesting, sell a portion to cover taxes). If this is something your firm has recently analyzed or executed, I would appreciate the opportunity to compare notes or takeaways.”
Peer answer 1: “My company has used the sell to cover approach for [at least] the past three years.”
Peer answer 2: “We went the opposite way and switched from sell to cover to net share settlement last year. I am happy to talk about the analyses that we did.”
Plenty of cash: In a follow-up email exchange, the member doing the opposite of what the questioner is considering explained why: “There are many reasons, but simply, we have plenty of cash to pay the tax. In general, I don’t think you want to issue equity just to pay a tax bill as equity is the most expensive form of capital.
- “Most tech companies issue RSUs on a quarterly basis where all the employees receive their awards on the same day; thus if you sell to cover, you will have four days a year with heavy selling pressure due to stock compensation.
- “There are also employee experience issues with sell to cover. The employee gets the tax amount calculated on the day before the grant. Then they get the stock in their brokerage account on the day of heavy selling, which likely brings down the stock price; and if they sell, they are selling stock at a price lower than the price their taxes were calculated. That causes a lot of grief for employees.”
