Should I take cash, RSUs, at-the-money NSOs, or out-of-the-money options?

Some companies, such as Spotify, allow their employees to pick the type of equity that they want.

This means that employees can choose among cash, Restricted Stock Units (RSUs), at-the-money options, out-of-the-money options, or some combination thereof.

Unrelated sidenote: this is a great, employee-friendly gesture (I applaud the companies that offer this perk). Interestingly, research shows that too many options (no pun intended) can lead to the Paradox of Choice: more choice often leads to more regret of that choice, often leads to less overall contentment.  You can’t have your cake and eat it too. But I digress…

So should you take the cash, RSUs, at-the-money NSOs, or out-of-the-money options?

Let’s start with the qualitative considerations, which are likely the greatest determinants here: personal circumstances, risk tolerance, and your household cash flows are critically important.

You first and foremost want to be able to sleep well at night. Some of these choices (hello, options) are far riskier (in that they could easily be completely worthless) than the cash bonus or RSUs. Plus, options require you to exercise them, which not only cost you money upfront – but could make the payout significantly less than that of a RSU share which requires no such exercise.

Here's my general ranking of “least risky” to “most risky”:

1. Cash is the least risky.

Probably no surprise that cash is the least risky – but it also means that you give up any possible upside. That’s not necessarily a bad thing, particularly if you want a guaranteed amount and/or need that cash to, say, remodel your basement, pay off student loans, pay for a wedding, etc. But, in theory, there is also no incentive to hit certain targets, milestones, or otherwise help improve the company’s performance.

2. Restricted Stock Units (RSUs) are the next least risky.

Aside from cash, RSUs are generally the least risky in that they’ll at least be worth something upon vest (unless the share price goes to $0). And, unlike with cash, RSUs have upside potential. This is because companies don’t grant you a set dollar amount of RSUs – rather, they’ll grant you a set number of RSUs. For example, the company won’t grant you $100,000 worth of RSUs. Rather, they would grant you 5,000 units that, at the time of grant, are each worth $20/share. Upon vest, the actual value of those RSUs could be lower, the worth the same, or worth more. Upon vest—and if you sell immediately—the RSUs are as good as cash. Generally, I’d say that most people choose a combination of cash and RSUs because of the guaranteed value plus upside potential.  

3. At-The-Money-Options are risky but have high upside potential.

At-the-money options is where we cross the Rubicon from “not that risky” to “we’re making some big bets here”. In other words, now we’re gunning for big payouts. But there is certainly “no free lunch,” as they say, and big payouts with high upside potential also come with the risk of easily becoming worth less or worthless altogether. That’s totally fine for some folks, while totally not fine for others. To each their own.

At a high level, at-the-money (ATM) options are options granted at the current value of the company. For example, if the company’s stock price is $20/share then an at-the-money option would have a “strike price” of $20/share. (Note: companies cannot grant in-the-money options, e.g. anything lower than the current $20/share price). The ATM Option gives you the right – but not the obligation – to exercise the options if the stock price is rises higher than $20/share. However, these options would be considered “underwater” (i.e. worthless) if the share price falls.

Herein lies the risk: how bullish are you on your company? Bullish enough to bet that the price rise dramatically from where it is today? Maybe so.

Even if you are incredibly bullish, remember that options require you to exercise them – which means that you need to buy the shares outright. For example, if you have 5,000 options at a $20 strike price, you will need to first plunk down 5,000 x $20 = $100,000 just to own the shares. That exercise cost eats into your net profits and its very possible that even if the stock price has increased, it may not have increased enough to make the payout of at-the-money options greater than what you could have received from vested RSUs.

In other words, you need to consider what share price the company would need to attain in order to make you indifferent between RSUs and options.

4. Out-Of-The-Money Options are by far the riskiest

And, finally, we have out-of-the-money options (i.e. options that are priced higher than the current value of the stock). These are certainly the riskiest equity type (for all the points above) and because the stock price is currently below the actual grant price. So, not only does the stock price need to rise above the grant price for these options to be worth anything, but they also likely need to get far above the grant price to be worth a greater payoff than that from RSUs.

Consider this example:

• Stock price is currently $20/share.

• You can choose between 1,000 RSUs or 5,000 OTM options.

• OTM Option strike price is at $30/share.

• Assume that the stock price soars 75% to $35/share.

• Assume that you chose the OTM options.

The stock rose 75%! Great news, right?!  

Wrong. You actually would have netted greater profit (post-tax and post-exercise) had you chosen RSUs. Without getting too much into the math, this is primarily because you had to pay $150,000 just to exercise your options, which significantly eroded your net cash.

Modeling the probability-weighted expected value is important

When I work with clients, we discuss not only the qualitative considerations, but we also look at the numbers and the expected value of each equity type. This example, below, is fictitious. But by considering the upside potential (and associated probability) as well as the downside potential (and associated probability), we can reasonably gut check what needs to be true in order to make a decision.

The future, obviously, is unknown so the numbers are guaranteed to be wrong. But the models can be a helpful exercise nonetheless.

If you have questions about your equity comp or which equity type you should take, feel free to reach out to me directly. I’d be glad to help.

Good luck!