Restricted Stock

What is Restricted Stock?

Restricted stock is stock of a business entity that is not transferable until certain conditions are met. When said conditions are satisfied, the stock becomes transferable by the individual holding the restricted stock. Stock, in general refers to a percentage ownership of a company. When any form of stock has limitations placed on it, the investment vehicle is deemed to be restricted.

The Vesting Period:

The most common restrictions attached will require a defined length of time to pass or a specific goal to be accomplished before the restricted stock may be sold. This period is known as the vesting period.

The vesting period refers to the length of time before all the restrictions attached are lifted. Restricted stock is commonly awarded to employees of companies; when the employee receives the stock a vesting period will be attached which will force the employee to remain with the company for a certain period of time before the employee can profit—through the sale of—the restricted stock. If the employee leaves from or is terminated by the company the restricted stock must be forfeited. When the employee fulfills the restrictions attached, they are said to hold the award of the restricted stock, meaning the right to sell or do as they please.

How is Restricted Stock Different from Stock Options?

Both stock options and restricted stock have vesting periods. The primary difference between the options is found at the end of the vesting period. When a stock option vests, the employee is given the option of purchasing or not purchasing the stock at the strike price (specific price outlined in the option agreement). The employee does not own any stock until they exercise the option and purchase the bundle. When the employee purchases the stock, they may do as they please with the shares, including sell it. By contrast, when a restricted stock vests, the employee immediately owns the stock and may do whatever they want with it.

The benefit obtained from the two investments is largely dependent on the change in the underlying stock price. In general, if the stock price rises, stock options provide a greater profit. Both compensation packages enable the employee to sell at a higher market value, but with a stock option, the employee does not have to commit to the purchase until the stock price reaches a targeted point. However, if the price decreases, restricted stock is more desirable.

Restricted stock compensation packages are typically smaller—in regards to amount of shares—than stock option grants. A stock option grant will be, in most instances, will be two to three times larger than a restricted stock compensation package. The difference is size is used to offset the risks associated with a stock option grant.

Restricted stock, like stock option grants, are attached with multiple tax considerations. If you receive either from your employer be sure to consult with a qualified accountant or tax attorney to get caught up on the necessary obligations.