What are restricted stock awards (RSAs)?

Takeaway: RSAs are shares of stock issued to early employees and consultants under an equity incentive plan. These folks purchase the shares directly and can start their long-term capital gains holding period right away. RSAs are a useful equity compensation tool while the price of the stock is very low.

Restricted stock awards (“RSAs”) are a type of equity compensation often used by startups to incentivize and retain employees. A restricted stock award is a grant of company stock that is subject to certain restrictions or vesting requirements. These restrictions may include a requirement that the employee remain with the company for a certain period of time before the stock fully vests.

Employees or other service providers that receive RSAs typically pay for them either with cash or with services. It is conceptually similar to early exercising an NSO (where the purchase price is equal to the fair market value on the date of grant).

RSAs often (though not always) carry vesting requirements similar to those applied to employees and service providers when issuing stock options. As a result, 83(b) elections are commonly filed within 30 days of the date the RSA is granted.

Benefits of RSAs

RSAs are most useful when issuing equity compensation to employees and other service providers while the price of the company’s stock is still low enough for the employee or service provider to pay for the stock out of pocket. It is possible to pay for an RSA with a promissory note, but IRS regulations provide that the promissory note must be substantially full recourse to the employee or service provider.

Issuing an RSA instead of a stock option also starts the capital gains holding and qualified small business stock (QSBS) holding periods, which begin when the stock is issued. If achieving long-term capital gains is important to the employee or service provider, this may be beneficial.

Drawbacks of RSAs

The most significant drawback of RSAs is that the recipient has to pay for the stock. As referenced above, this payment can be with cash, a promissory note, or, in many cases, services. Practically, it can cost more in legal fees than it is worth to accommodate employees and service providers that want bespoke equity compensation and I encourage companies to keep it simple.

Another drawback to issuing an RSA is that the recipient should almost always file an 83(b) election within 30 days of grant. Failing to file an 83(b) election has negative tax consequences for both the recipient and the company for which there is no perfect fix. This can be made more complicated by the illiquid nature of the company’s stock - it can be difficult to accurately assess the value of a startup’s stock.

Conclusion

Restricted stock awards can be a valuable tool for startups to incentivize and retain top talent, particularly while the stock is affordably priced. By aligning the interests of employees with those of the company and its shareholders, startups can create a culture of collaboration, innovation, and long-term success. However, it's important for startups to carefully consider the tax, accounting, and legal implications of restricted stock awards, and to consult with qualified professionals before issuing them.