To acquire and retain talented employees in the firm, many companies grant their employees equity compensation, i.e. ownership stake as compensation. When employees get an ownership stake, they also work to achieve company goals since they can get a part of the company’s profit. Various forms of equity compensation include performance shares, stock options, restricted stock, etc.
In this article, we will discuss what restricted stock is, the characteristics, types, advantages and disadvantages of restricted stock and restricted stock versus stock options.
What Is Restricted Stock?
Restricted stocks are unregistered shares that are non-transferable for holders until they meet certain conditions. Well-established companies offer restricted stocks to company executives and directors as a form of equity compensation. Some restrictive conditions may be particular tenure or specific performance goals.
Characteristics Of Restricted Stock
Restricted stocks are not registered with any stock exchanges and, therefore, are not publicly available for trading.
Restricted stock units have a vesting period, i.e. a prefixed period till which the holder cannot transfer or sell the shares.
Transfer of ownership
The holder of stock would only be able to transfer the stock ownership after fulfilling certain conditions, like the end of the predefined period, financial performance goals, earnings per share (EPS) goals, etc.
Different Types Of Restricted Stock
Restricted stock units (RSUs)
Let’s understand what restricted stock units are. An RSU is typically a promise an employer gives to an employee to provide him/her with a particular number of shares at a prefixed date in future. Since RSU is a promise and not actual stock, the holder does not enjoy voting rights initially.
If the employee continues working with the company until the specified time and exercises the RSU, the RSU converts to actual stock, and he/she receives all the associated rights. The employee may opt to receive cash equivalents instead of stock, subject to plan rules.
Restricted stock awards (RSAs)
RSAs are similar to RSUs in several ways because they are also part of employee compensation and have a fixed vesting period. A significant difference between them is that the employees holding RSAs enjoy voting rights as soon as they receive RSAs because they immediately get stock ownership.
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Advantages And Disadvantages Of Restricted Stock
As mentioned, restricted stocks have a vesting schedule, and the employees get actual stock ownership when they meet vesting conditions. If the vesting condition is related to tenure, it may motivate the employees to continue working with the company for a long time. Vesting conditions related to performance targets would encourage them to perform better.
Better than stock options
Stock options are the right, but not the obligation, to buy a particular number of shares at a prefixed price, known as the strike/exercise price, and a specific date in the future. The value of stock options depends on the strike price and the stock’s current market price at the exercise time.
If the strike price is higher than the stock price at the exercise date, the stock options will likely become worthless, which doesn’t happen in the case of restricted stocks. Restricted stocks at least possess some value at any time.
Dividend and voting rights
After the vesting period, the restricted stock converts to common stock and offers benefits like dividends and voting rights. However, this only happens if the company chooses to do so.
Employees do not immediately receive the stock. They need to fulfil vesting conditions to receive the stock. If they don’t, they will have to forfeit the shares.
The employee needs to pay tax on restricted stock when exercising since the amount of vested stock acts as ordinary income for the relevant year. Even if the stock price falls, and the employee doesn’t get profit, he/she needs to pay tax.
Restricted Stocks Versus Stock Options
Here is the comparison of restricted stocks vs stock options.
|Point of difference||Restricted stocks||Stock options|
|Granted by||Well-established companies||Start-ups and growing companies|
|Valuable||Always possess some value||Valuable when the stock’s current market price > the strike price.|
|Motivating tool||Motivate employees to achieve long-term goals.||Motivate employees to perform better in the short term.|
|Payment mode||Stocks or cash equivalents||stocks|
Restricted stock may help companies prevent untimely selling of stock, which can prove unfavourable for the company. It may also help the employees participate in the company’s profit. However, employees avail of such benefits only when they meet vesting conditions, which could be a tough task.
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Restricted stocks are unregistered shares the holder cannot transfer until certain conditions are met. In contrast, unrestricted stocks are not subject to such restrictions for ownership transferability.
The company offers restricted shares to the company executives, whereas common stock to the general public. It is easier to transfer and sell common stocks than restricted stocks.
You can sell your restricted stock after the vesting period is over. However, you cannot sell restricted stock units within the vesting period.
You need to hold restricted stock until the end of the vesting period. After the vesting period, you may decide the right selling time based on the company’s growth prospects and your investment objective.
You need to pay taxes on the restricted stock at the exercise time.