Pre-IPO RSUs – Single Trigger vs. Double Trigger Grants

Many late-stage pre-IPO companies begin transitioning away from stock options in favor of RSUs as they get closer to an expected liquidity event. Without a liquid market to sell shares, it can be challenging for employees at pre-IPO companies to pay the taxes as their RSUs vest – either because they don’t want to pay taxes on illiquid “paper” wealth, or because they can’t afford to.

Enter the double-trigger RSU. In essence, these are structured to defer taxes until after an IPO or acquisition by adding a “liquidity event requirement” to a standard time-based vesting schedule. If you’re at a private company and have RSUs or expect to transition from options to RSUs soon, read on to understand the impact of having single-trigger or double-trigger RSU grants and how to know which one you have.

What is an RSU? 

An RSU is a type of equity award representing shares of your company’s stock. Think of it as a commitment by your company to give you a defined number of shares when certain requirements are met (known as vesting).

You don’t really “have” anything other than this promise when you first receive your RSU grant. You’ll only own the shares once the vesting requirements are met and your company delivers the shares to you. 

Vesting and delivery come into play when discussing differences between single-trigger and double-trigger RSUs, most importantly in terms of the timing of taxes owed.

RSU Vesting Conditions

To physically own shares from an RSU grant, you need to meet the vesting requirements laid out in your RSU grant. These can come in different forms, but for pre-IPO RSUs the most common are service-based (or time-based) and a liquidity event requirement (sometimes called a performance requirement).

Service or Time-Based Vesting

With service or time-based vesting, your RSUs vest incrementally over time, and you earn shares as you meet those time milestones. Think of service-based vesting this way: the longer you stay at your company, the more RSUs will vest. 

In my experience, a service-based schedule is the most common vesting condition and is almost universal for “regular” employees and executives. They can have a vesting period from immediate to over five years, vesting frequency of monthly to annually, a cliff vest (or no cliff), and even a non-uniform schedule over time. These all fall under service-based vesting.

You might see this in your grant document as something like, “The Service-Based Requirement will be satisfied in installments as to 6.25% of the RSUs subject to this award when you complete each successive 3-month period of continuous Service after the Vesting Commencement Date set forth above.”

Liquidity Event Requirement

A liquidity event requirement means that your RSUs will only vest after a liquidity event occurs, which can be an IPO, an acquisition, or some other defined event. Liquidity event requirements are becoming more and more common for RSUs issued at pre-IPO companies and are usually paired with a time-based vesting schedule (hence the “double-trigger” name).

Liquidity event requirements can include a buffer period after an IPO that allows vesting to be further deferred until a 6-month lock-up period is over, but some don’t. Your grant document will outline when vested shares are delivered.

A liquidity event requirement might be a vesting condition, a requirement for settlement, or appear in both places. You might see something like this in your grant: “The Liquidity Event Requirement will be satisfied (as to any then-outstanding RSUs that have not theretofore been terminated pursuant to Section 2 of the Restricted Stock Unit Agreement) on the earlier to occur of (i) an IPO or (ii) a Sale Event.”

Other Vesting Conditions

RSUs can have other requirements for vesting: stock price achievement, personal achievement, team/department achievement, etc., and are outside of the scope of the single/double trigger discussion. Most likely, you’ll have a service-based schedule, possibly a liquidity trigger, and no other vesting requirements.

Settlement, Issuance, and Delivery

Settlement, issuance, and delivery is a critical aspect of RSU taxation, and these terms refer to the point in time when shares from an RSU vesting event are physically transferred into your possession. For the rest of this article, I’ll refer to settlement, issuance, and delivery interchangeably. 

Usually, settlement happens immediately after a vesting event, but in some circumstances and depending on the structure of a grant agreement’s vesting schedule, a company will defer the settlement of shares. 

While we generally think of “vesting” as the trigger point for taxes, settlement can be the actual time when taxes are owed, depending on how a grant’s vesting and settlement rules are defined. More on that later.

Single-Trigger or Double-Trigger RSUs

We’ll define single-trigger and double-trigger RSUs based on whether both time-based and liquidity event requirements exist, and whether taxes might be owed before a liquidity event.

Single-Trigger RSUs

Single-trigger RSUs only have a service or time-based vesting schedule. They vest and are taxed based on that schedule alone. The value of the shares is taxable as wage income and subject to tax withholding requirements as they vest, even if your company is still private and you don’t have the ability to sell your shares to pay the taxes.

It's important to check the settlement terms for a liquidity requirement too. If there's no liquidity requirement in the vesting or settlement section, you probably have a single-trigger grant.

Double-Trigger RSUs

Many people don’t want to be locked into paying taxes over time to acquire equity in a private company, and adding a liquidity event requirement to a time-based schedule means that those RSUs aren’t taxable until after an IPO or acquisition. Remember that both triggers must be met for double-trigger RSUs to vest – an IPO doesn’t mean that all of your RSUs automatically vest; you still need to hit your time-based milestones too.

The liquidity event requirement might be a vesting condition or a requirement for settlement. Either way, taxes for a double-trigger grant will be deferred until after an IPO or acquisition.

Things to Think About

Generally, you won’t be able to choose between receiving a single-trigger or double-trigger RSU grant. However, even without the option to choose, it’s important to understand how your single or double-trigger RSU grant might impact you.

Tax Withholding and the “Square-Up” Cash Flow Issue

RSUs are taxed as compensation income when they vest, so taxes owed include federal income taxes, Social Security and Medicare taxes (FICA/payroll), and state and local income taxes. Like other compensation income, income tax withholding is mandatory, but it’s a little different than the withholding on your regular salary.

RSU withholding is a flat 22% for income up to $1 million for federal taxes (37% for income above $1 million), plus applicable payroll taxes, plus your state’s mandatory withholding rate (California is 10.23% for income up to $1 million). 

Under the assumption that you’re able to withhold shares instead of cash (net withholding), where’s the cash flow issue for single trigger RSUs? It comes down to that flat 22% federal tax withholding rate. If you’re in the 24% tax bracket or higher, you mush make up the difference above the 22% withheld. Since there’s no public market for your company’s stock yet, you can’t just sell a few extra shares to make up for the deficit – you’ll need to come up with additional cash.

To illustrate this, let’s say you’re in the 24% tax bracket and vest into $25,000 worth of RSUs. To make up the 2% difference you’ll need to square up your federal tax liability with $500 in cash. Not terrible, but if you get pushed into the 32% bracket next year because of a promotion and the value of the RSUs you vest into increases to $40,000 (taxable value is the number of shares times the fair market value or 409a valuation for a private company), that $500 “square-up” amount turns into $4,000.

This same “square-up” issue can easily happen with double-trigger RSUs or RSU grants at public companies too, but at least in those cases you can prevent that by selling additional shares as they vest.

What If I Leave Before a Liquidity Event?

With single-trigger RSUs, this doesn’t matter. You’ll walk away with the shares you earned and give up any unvested equity. 

For double-trigger RSUs, you’ll need to read your grant document and company’s stock plan. Many plans ensure you won’t lose any RSUs “earned” through your time-based vesting schedule if you leave before the IPO. Those “earned” shares will automatically be delivered after the liquidity condition is met. However, other stock plans require you to be a current employee for both triggers, which means if you leave before a liquidity event, you could lose everything. 

Grant Expiration

Single-trigger RSUs don’t expire. Once they vest the shares are yours, and you can keep them however long you want.

Double-trigger RSU grants usually have an expiration date where the entire grant expires worthless (no shares are delivered) if the liquidity event trigger doesn’t occur within a certain length of time, often 5 or 7 years. But why the expiration date for double trigger RSUs? It’s a condition to allow tax deferral until after a liquidity event – maintaining a “substantial risk of forfeiture”. Unfortunate, but necessary. A longer time until expiration is better, of course.

If your double-trigger grant doesn’t have an expiration date, the “substantial risk of forfeiture” rule is likely being satisfied in another way, possibly by losing the shares if you leave before a liquidity event. 

Selling Pre-IPO Shares 

If your company allows pre-IPO sales of stock or sponsors an internal tender offer, you may have the opportunity to sell the shares from single-trigger RSU vesting before an IPO or acquisition since those shares are issued at vesting. Of course, there’s no guarantee that you’d be able to find a buyer.

This opportunity doesn’t exist for double trigger RSUs since you don’t actually own the shares until after a liquidity event (unless your company makes one-off exceptions or has special vesting clauses that allow for this).

Overall Tax Liability

The taxes owed on single-trigger RSUs vesting over several years will be spread out over those years. You might get pushed into higher tax brackets or have to “square-up” your taxes with cash, but all else equal, you’re likely to owe less taxes on the vesting than with a double-trigger grant.

As an extreme example, let’s say you have a $1 million RSU grant, price stable over time for simplicity, a four-year vesting schedule, and a salary of $0. A single-trigger grant will have $250,000 worth of RSUs vest each year for four years, and you’ll owe taxes from the bottom 10% bracket into the 35% bracket each year if you file single. But with a double-trigger grant, your entire grant could vest at one point in time if the liquidity event happens after the entire time-based schedule is completed. That’s $1 million of income in one year – you’d lose out on those lower tax brackets in the other years and owe a lot more in taxes overall.

This difference in overall taxes grows if the price increases over time, which we would hope happens, since vesting in earlier years would happen at a lower price for a single-trigger grant.

If you’re one of the lucky few to have the option to choose between a single-trigger and double-trigger RSU grant, weigh the risks and potential rewards when making your decision.

TL;DR

• Single-trigger RSU grants only have a time-based vesting schedule and the value of the RSUs are taxed as those time milestones are met, whether the company is public or still private.
• Double-trigger RSUs add a liquidity event requirement to the time-based vesting schedule, which defers vesting and taxation until after an IPO or acquisition. 
• You should think about tax withholding and if you’ll need to “square-up” any additional tax liability whether you have single-trigger or double-trigger RSUs, but the impact could be more significant for single-trigger grants. 
• Read your grant document carefully to understand which kind of RSU grant you have. Double-trigger grants often have an expiration date or forfeiture of shares if you leave before the liquidity requirement is satisfied. On the other hand, single-trigger RSUs could leave you in a cash crunch if you aren’t expecting a tax “square-up” as your RSUs vest.

If you have questions about your equity grant, I’d be happy to help you answer them. Feel free to send me an email or schedule a time to talk.