For example, a new tech startup might offer restricted stock to its key executives to provide additional compensation without the need for immediate cash. In addition, the stock may have a vesting timeline of five years before the executive has full ownership of the shares. The vesting schedule gives the executive an incentive to stay longer and work in the best interests of the company’s success.
How Restricted Stock Works
Restricted stock plans give employees of a company a personal interest in how well the company does. The vesting schedule of restricted stock units is usually dependent on length of employment or based on performance goals being met. Once you are fully vested, you have voting rights and possibly dividend payments with the shares you are granted. For example, your employer may grant you 3,000 shares of restricted stock in an agreement that states you will be fully vested after five years of employment (vesting a 20% portion per year) or if you meet specific performance goals. After you are fully vested, you now have full voting and dividend rights with the shares you were granted. Continuing the example above, let’s say the 3,000 shares are priced at $10 per share. After five years, you are fully vested, and the current stock price per share is $30. Your taxable income would be based on the price per share at vesting or $30 per share, times 3,000 shares, which equates to $9,000. If you received cash equivalents, you’d pay taxes in the year you received the cash. However, if you were compensated in actual company shares, you would be taxed once you sell the shares. In addition, it is possible to pay capital gains taxes if the price per share has increased between the time you received the shares and the time you sold them. Should you leave your employer before the vesting schedule has lapsed, you likely will forfeit your interest in the compensation plan.
Types of Restricted Stock
There are two types of restricted stock. They are restricted stock units (RSUs) and restricted stock awards (RSAs). Both are stock compensation plans given to company employees that have certain restrictions to be met before the stock can be delivered to the employee. The difference between the two lies in what those rules are and when the shares are granted to employees.
Restricted Stock Units (RSUs)
RSUs are stock ownership as a form of compensation offered to employees and are issued on a defined vesting schedule. In most cases, the employee must work for the company for a specified time before he or she can have full rights of ownership of the stock. Depending on the plan rules, employees may choose to receive their RSUs in stock shares or cash equivalents equaling the value of the shares at the time of delivery.
Restricted Stock Awards
RSAs are very similar to RSUs. They are a type of additional employee compensation that also comes with rules and restrictions, such as a vesting schedule. However, rather than being part of a long-term compensation plan often laid out in an employment offer letter, RSAs are “awarded” to employees much like a bonus.
Restricted Stock vs. Stock Options
Restricted stock and stock options are some of the more popular equity compensation plans offered by employers. What’s the difference between the two? As an investor, it’s also wise to understand different equity compensation plans a company offers because it can significantly affect a company’s balance sheet and future payroll obligations.
