A new equity paradigm for private companies: liquid RSUs

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Today, offer letters from Carta look a bit different than they did when I joined the company as CFO in 2017. That’s because we’ve started to issue new hires equity grants in the form of restricted stock units (RSUs) rather than options.

We decided to make the change because the fair market value of our stock was rising, to the point that it was no longer reasonable to expect employees to pay to exercise their options. Employees with RSUs have a right to their shares; however, they do not pay an exercise price. Once the RSUs vest and settle, the employee owns the equity outright.

As we made this decision, though, we weren’t interested in implementing the traditional double-trigger RSU structure. 

Many companies issue double-trigger RSUs. The “Double-trigger” indicates that two events are required before the employee owns the shares. Generally, the first trigger is time-based vesting and the second is a change in control or a liquidation event like an IPO. Gains from the value of the RSUs are taxable once both triggers occur, however, now that the shares are publicly traded, employees can sell shares to cover their tax obligation. 

But for Carta, this wasn’t an ideal solution. Companies are now waiting an average of 11 years to go public. We didn’t want to force our employees to wait for any significant length of time to access liquidity. 

But traditional single-trigger RSUs weren’t a good solution for us either. In the case of single-trigger RSUs, an employee faces a tax obligation once their shares vest, even if a liquidation event hasn’t happened yet. That means the employee would have to pay a significant tax bill on the value of the vested grant without being able to sell shares to offset the liabilities. 

A handful of private firms can offer single-trigger RSUs without this liability because they can afford to cover the cost of tax withholding for their employees—but most companies simply don’t have the cash on hand. 

There has never been a solution for private companies who want to offer RSUs and provide employees with liquidity to cover the tax burdens within a reasonable timeframe. 

For Carta, that changed with the launch of CartaX—the first listing venue ever approved by the SEC for private companies. We listed our own shares on CartaX earlier this year to be able to access liquidity every quarter. 

With this liquidity, we’re able to approach equity compensation in a new way: We can now offer RSUs and Carta will cover the tax obligation through net settlement. We commit to withholding RSUs equivalent to the tax liability owed by our employees at settlement. Carta then pays the state and federal taxes owed directly to the government—with no action required by our employees. 

Here’s how this plays out for a hypothetical recent hire; let’s call her Michaela. 

  • Michaela received an offer from Carta that includes an RSU award valued at $100K, vesting quarterly over four years with a one-year cliff. Her start date was January 15, 2021. 
  • On her first vesting date—April 1, 2022—Michaela will vest in 14 months’ worth of shares. That amounts to about $30K. (This grant amount is probably unique to Carta. Unfortunately, most companies only offer employees 12 months’ worth of shares on their first quarterly vesting date, no matter when they started.)
  • Carta then has until the end of the tax year to settle Michaela’s shares, at which point she will owe (hypothetically) approximately $10K in taxes. The end-of-year buffer gives Carta time to access enough liquidity via CartaX to cover Michaela’s tax liabilities.
  • In Q4 of 2022, Carta runs a transaction to sell enough shares to cover her tax liabilities. This transaction closes on November 15.
  • This means that on November 15, 2022, Michaela’s shares settle. Carta has already withheld the necessary funds for tax purposes, and Michaela now owns $20K in Carta shares, only 22 months after her start date.
  • Carta continues to offer quarterly CartaX events and Michaela will have the option to sell her shares in the future.

This completely changes the calculation for equity compensation for privately held companies. It means that private companies can consider a new kind of single-trigger RSU—a liquid RSU—without requiring a cash outlay for an option exercise, waiting for an acquisition or IPO, or putting their employees at risk of an operational tax burden. 

 

DISCLOSURE: This communication is on behalf of eShares Inc., d/b/a Carta, Inc. (“Carta”). This communication is not to be construed as legal, financial, accounting or tax advice and is for informational purposes only. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.
©2021 eShares Inc., d/b/a Carta Inc. (“Carta”). All rights reserved. Reproduction prohibited.

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