What are restricted shares? Startups and established companies either public or private are known to issue a certain kind of shares to their employees as an incentive; these shares are known as restricted shares. There are two types of restricted shares: RSA and RSU; we will look at what they are and their importance. Additionally, we shall take a look at these types and examples. So whether you are a company considering issuing these shares or an employee seeking to get them, you will learn more about them below.
What are restricted shares?
Restricted shares are shares that businesses give to their employees. They are mostly issued as an incentive so that the employee keeps working in the issuing company for a specified period. These shares generally come with conditions that must be met by the employees hence they are named restricted shares due to the restrictions they impose.
Although any business can issue restricted shares to their employees, they are most commonly issued by large-cap and mega-cap companies that are usually well established and want to give their employees incentives in order to ensure that the companies maintain a certain level of success or attain new standards.
Restricted shares are similar to equity shares in that they are an equity stake in the company. They are usually unregistered with the Securities and Exchange Commission (SEC). Generally, restricted shares cannot be fully transferred from the employer to the employees or from the employee to others and cannot be sold until after their vesting schedule. The vesting schedule outlines the conditions that must be met by an employee before they have full ownership of the previously issued restricted shares. When the requirements stated in the vesting schedule are met, the shares are then distributed to the employees, or a cash equivalent of the shares is given. Whether it is the shares that are given or cash equivalent depends on the restricted share plan. Once the vesting schedule is met, the shares become unrestricted.
Usually, employees who are given these shares are given on a condition that they must continue working in the company for a specified period or until certain corporate milestones such as meeting a specific financial target, accomplishing a particular goal, meeting a certain number of sales, being able to expand to certain regions, etc. Any employee who fails to stay with the company until any of the specified conditions for the issue of the restricted shares are met automatically forfeits their rights to the shares. Furthermore, if the employee is unable to meet up with the conditions by the end of the restricted period, they also forfeit the shares.
Restricted shares are also known as section 1244 stock or letter stock or restricted securities. A form for the restricted share agreement is available and can be accessed on the SEC website.
Reasons why companies issue restricted shares
- Retaining top talents
- Reducing cash expenditures on wages
- Motivating employees
- Rewarding dedication to duty
- Aligning employees’ goals with that of the company
- Retaining key officers
Listed above are the major reasons why businesses issue restricted shares to their employees.
Conditions associated with these shares
- The company must meet the specified earnings per share goal
- Continued employment with the issuing company for a certain period
- Attaining a specific sales target for the business
- Maintaining a certain client base for the company
- Expansion of the company to some regions
Note that the list above is not exhaustive and these conditions may differ from one company to another. However, it is mostly centered around continuous work in the company, attaining certain for the company, and the company meeting some corporate milestones.
Types of restricted shares
- Restricted share award (RSA)
- Restricted share unit (RSU)
The above are the two types of restricted shares. The major difference between the restricted share award and the restricted share unit is that the former is granted to the employee immediately for free or at a discounted price while the latter is granted for free at a future date.
Restricted share award (RSA)
A restricted share award is also known as a restricted stock award. It is a type of restricted share issued by companies to aid their employees in owning the company’s shares in addition to their regular wages. It is usually awarded as payment for exceptional work ethic or recognizing their long-term service to the company in which case the employee doe not pay for the shares. Otherwise, it is sold to the employees at a discounted price which is usually lesser than its market value. In a case where these shares are awarded for free, the employee cannot redeem them for cash. RSAs are usually granted immediately after they are awarded and the employees get all the rights that other shareholders have such as dividend payments and voting rights.
Restricted share unit (RSU)
The restricted share unit is also known as the restricted stock unit. These shares are generally promised to employees at a future date as long as the employees meet the conditions attached to them. They typically have a vesting schedule that specifies how many shares the employees get and at what time. Employees must also continue working with the company within a certain period of time (known as the vesting period).
Although RSUs grant employees interest in the company’s share, it is of no tangible value to them until the restricted period is over. After this period, the employee has the option of either receiving the shares or a cash equivalent. If the employee chooses the former, they enjoy shareholder rights, however, some companies do not confer voting rights to these shares.
RSA VS RSU
Although both restricted share awards and restricted share units are shares issued to employees by their employers, they have other similarities and differences which we shall discuss further. But before then, a summary of the differences that exist between these two shares is outlined in the table below.
|Restricted share award (RSA)
|Restricted share unit (RSU)
|Usually startups companies
|Well-established private and public companies
|Free or at a discount
|Time-based and performance-based
|Can be repurchased
|Begins from the grant date
|Begins after the vesting date
|Way of collection
|Can only be received as shares
|Can be received as shares or cash equivalent
|Way of grant
|Granted at a future date
Similarities between restricted share award and restricted share unit
- Both of these shares can get forfeited if the employee does not meet the restrictions placed on them at the end of the vesting period.
- RSAs and RSUs are issued to employees by their employers.
- Both can enjoy shareholder rights after the restricted period.
- Both RSAs and RSUs are a type of restricted shares.
- Both shares are used as incentives or a form of compensation.
Restricted share award and restricted share unit differences
- Restricted share awards are mostly issued by startups whereas restricted share units are issued by either private or public established companies and conglomerates.
- RSAs are usually awarded for free or at a discounted price while RSUs are given for free.
- Restricted share awards are granted immediately they get awarded whereas restricted share units are given in the future.
- RSAs normally have a time-based vesting schedule while the vesting schedule for RSUs is usually tied to the employee’s performance, corporate milestones, and a specified timeframe.
- Restricted share awards cannot be received as cash equivalents, they can only be collected by the employee as shares. Restricted share units can be given either as shares or cash equivalents.
- RSAs are subjected to tax from the day they are awarded while RSUs only get taxed when the vesting schedule has elapsed.
- Unvested restricted share awards can be repurchased back by the company at the termination of the employee’s job whereas restricted share units are forfeited and go back to the issuing company at termination.
Restricted shares examples
The restricted shares examples given below are hypothetical scenarios. Companies that issue these shares might have a variety of conditions on which they give these shares to their employees although most of the conditions are either time-based, milestone-based, performance-based, or a mix of all. In addition to those, the Securities and Exchange Commission (SEC) also has a form that outlines some conditions for the issuing of these shares.
Assuming you are an employee for a well-established company like Google and you are one of their best technicians. In order to motivate you to keep doing exceptionally well at your job, they can decide to offer your one hundred (100) restricted shares in addition to your wages. These shares will however be given on the condition that you work in the company for at least ten years after which you receive the shares on the vesting date and your shares become unrestricted since the condition attached to them would elapse on that date.
Suppose you are a sales executive at a startup company that produces furniture. If the company has a sales target they hope to accomplish within a stipulated period, they could offer you restricted shares on the condition that you:
- Sell at least a thousand (1,000) pieces of furniture each year
- Work with the company for a minimum of seven (7) years
With these restrictions placed on your ownership of the shares, it will serve as a motivating factor for you to ensure you meet the stipulated number of furniture sales each year and also work in the company for the defined time frame.
For instance, a company seeking to keep its top executives from leaving them and going to work for their competitors can award the restricted shares on the following condition:
- The executives can not work at firms that are in direct competition with them.
- They have to work in the company for at least fifteen (15) years.
- They cannot own any business that has the same business model as the company.
- They cannot sell these shares to anyone working in or associated with a competing company.
- They forfeit their rights to the shares if they break any of the earlier-mentioned conditions.
By the above conditions, the company has been able to restrict its top executives from working with or becoming their competitors otherwise, the employee forfeits their shares.
A real estate company could grant two hundred (200) units of restricted shares to an employee provided that they are able to sell two houses monthly for a period of three years. With this, the company has successfully tied the share issue to the performance of the employee. It also serves as a motivation factor for the employee to ensure that they meet the stipulated target within the period stated.
Restricted shares vs stock options
Before the advent of restricted shares, stock options were the known form by which a company can compensate its employee but that has changed now that restricted shares can also be used for the same purpose. We shall discuss some of the differences and similarities between these two incentives but before that, let us understand what stock options are.
What are stock options?
Stock options are contracts between two parties that give holders the right to buy or sell an underlying security instrument or asset at a preset price within a stipulated period.
Stock options that deal specifically with employee compensation are termed employee stock options (ESO) which are usually a contract between the company (employer) and the employee. These ESOs give the employee the right to buy the company’s stock at a predetermined price within a specified time.
Usually, the employee is not obligated to exercise this right and could choose to exercise it or not. If the employee chooses to exercise their rights, they will have to do so within the stipulated time, otherwise, it becomes void.
Additionally, even if the current market price is higher than the predetermined price, they still get the advantage of buying the stocks at the lower predetermined price if it is within the stipulated time stated in the stock options term sheet.
Let us have a look at some of the differences and similarities between restricted shares vs stock options.
Restricted shares vs stock options differences
Although both restricted shares and stock options can be used by companies to compensate their employees, they have some differences which we shall outline in the table below.
|Shares automatically vest once all conditions are met and get deposited into a brokerage account for the employee.
|The employee needs to exercise their right to either hold the shares or sell them.
|Shares or cash equivalents are given
|Only shares are issued
|Generally given for free
|Has to be purchased
|Became more commonly used in 2006 after the changes to generally accepted accounting principles (GAAP)
|Were more commonly used before the changes to generally accepted accounting principles (GAAP) which became effective in 2006
|The value of restricted shares is its fair market value.
|The value of stock options is the difference between its exercise price and the market value of the stock.
|The value of stock options is the difference between their exercise price and the market value of the stock.
|A contract that gives the employee the right to purchase a company’s shares at a specific date in the future.
|Generally considered less risky since the employee receives the shares with their fair market value.
|Considered riskier since the employee purchases them at the exercise price. This is especially true if the market price is less than or equal to the exercise price.
Similarities between restricted shares and stock options
- Restricted shares and stock options are both forms of employee compensation
- Both involve issuing shares by companies to their employees
- Both restricted shares and stock options have two basic types
- Restricted shares and stock options can both be traded
- Both usually have vesting requirements
- Restricted shares and stock options are usually time-based
Frequently asked questions
When are restricted share units taxed?
Restricted share units can be taxed as ordinary income in the year they vest. The employees that hold these share units can also be taxed on the capital gains made on the shares. The taxation of restricted shares is a bit complicated. Therefore, in order to fully understand how the taxation of these shares works, you should check section 1244 of the Internal Revenue Code (ICR) as that is what governs its taxation.
What is the difference between restricted and unrestricted shares?
As both their names imply, restricted shares have specified conditions that must be met before they can be transferred, bought, or sold. Unrestricted shares, on the other hand, have no conditions attached to their transfer, purchase, or sale. Both, however, can be used for employee compensation.
What does RSU stand for?
RSU stands for restricted share units.
What is vesting?
Vesting is legal terminology that has to do with earning the right to own a particular asset. In the case of restricted shares, vesting is the process whereby the employee earns the right to own the restricted shares by meeting the conditions attached to them.
What is a stock award?
A stock award is a form of employee compensation that grants the employee a certain number of restricted shares for free or at a discount. It is commonly referred to as a restricted stock award (RSA)
What does it mean when shares are restricted?
When shares are restricted, it means that they cannot be transferred, bought, or sold until the specified conditions (restrictions) are met.
What is a vesting schedule?
A vesting schedule is part of the employment compensation agreement that outlines the timelines that must be met by the employee before they get ownership of the company’s share. The vesting schedule is commonly used by employers when granting restricted shares to their employees.
What is the difference between RSU and stock options?
A restricted stock unit (RSU) is usually given to the employee for free while stock options are normally bought by the employee.
What is a vest date?
The vest date is the date on which the restrictions attached to the restricted shares that an employer has given their employee are met. On the vest date, the employee has full ownership of the share units given.
Can you sell unvested stock?
No, you cannot sell an unvested stock because the restrictions attached to it have not yet been met. Only fully vested stock (those with which the restrictions attached to them have been met) can be sold.
What happens to RSUS when you leave a company?
What will happen to your restricted share units (RSUs) when you leave a company depends on the terms in its agreement form. Generally, if you leave the company before your RSUs are vested, they become forfeited to the company.
Which is better, restricted shares or stock options?
Both restricted shares and stock options are used by companies for employee compensation. Deciding which of them is better depends on how you view them. Restricted shares are usually given for free and get deposited into a brokerage account for you by your employer once they vest. Stock options on the other hand have to be bought by you whenever you decide to exercise your right as far as the stipulated time frame has not elapsed.
What is the restriction period?
The restriction period is the period when the conditions attached to the restricted shares have not yet been met; in other words, the shares are still unvested.
We have seen the types of restricted shares: RSU and RSA and their differences. A lot of employees consider how companies compensate their employees when seeking employment and employers, on the other hand, always look for employee compensation that brings the most benefits to their businesses.
Whether you are an employer or an employee, understanding what restricted shares are is definitely a plus to you as it guides you to make the right decision for your company. Knowledge of what restricted shares are all about helps the employees to know if these shares are beneficial to them or not.Last Updated on November 2, 2023 by Nansel Nanzip Bongdap
Blessing's experience lies in business, finance, literature, and marketing. She enjoys writing or editing in these fields, reflecting her experiences and expertise in all the content that she writes.