Equity Compensation: RSUs, ESPPs, and Stock Options

Each is a way to tie part of your pay to the company's stock — sharing in the upside, but also the risk. This article explains how each one works; it does not cover when to sell or the tax treatment, both of which depend on your specific situation and jurisdiction.

Here's what each instrument is, how its value is determined, and the concepts (vesting, strike price) that run through all of them.

First: vesting, the concept behind all of them

Nearly all equity compensation comes with vesting — you don't own it all immediately; you earn it over time, as an incentive to stay. A typical schedule might vest over four years, sometimes with a one-year "cliff" (nothing vests until you've stayed a year, then it begins). Until equity vests, it isn't truly yours and is usually forfeited if you leave. Vesting is the string attached to almost every form of equity pay.

Restricted stock units (RSUs)

RSUs are the most straightforward. The company grants you a number of shares that vest over a schedule; as each portion vests, those shares become yours outright. Their value is simply the number of vested shares × the current share price — so if the stock rises, they're worth more; if it falls, less. Because you don't pay anything to receive them, vested RSUs essentially always have some value as long as the share price is above zero. That's the key difference from options, below.

Employee stock purchase plans (ESPPs)

An ESPP lets you buy your employer's stock, usually through payroll deductions, at a discount to the market price (often up to 15%). Many plans also include a "lookback" that applies the discount to the lower of the price at the start or end of the purchase period — which can make the effective discount larger. The mechanical appeal is direct: buying something at a discount to its market value means you acquire it for less than it's currently worth. Participation is optional and you choose how much of your pay to contribute, within plan limits.

Stock options

Options are the most misunderstood. A stock option gives you the right, but not the obligation, to buy shares at a fixed price — called the strike price (or exercise price) — usually the share price on the day they were granted. You benefit only if the share price rises above the strike price; then you can buy low (at the strike) and the shares are worth more. This gap is where options create value.

The crucial catch: if the share price is below the strike price, the options are worth nothing to exercise (why pay $20 to buy a share worth $15?). Such options are called "underwater." Unlike RSUs, which retain value as long as the stock is above zero, options can end up worthless even while the company's stock still has a price. That's what makes them higher-risk, higher-leverage equity.

The risk that ties it together

Equity compensation can build real wealth, but it concentrates risk: your income and a chunk of your investments both depend on one company. That's the opposite of diversification. If the company struggles, your pay and your equity can fall together — a version of the concentration risk covered elsewhere. Understanding this concentration is central to understanding equity comp; how any individual should respond to it depends on their circumstances and is exactly the kind of decision a qualified adviser (and, for tax, a tax professional) exists to help with.