Restricted Stock & RSU Fundamentals: What You Need To Know (Part 1)
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Along with (or instead of) stock options, your company may award you restricted stock or restricted stock units (RSUs). These are very different from options. To make the most of them and avoid costly mistakes, you need to understand how this form of equity compensation works.
In public companies, the shares are usually granted at no cost to you, and there is no exercise. Private companies can grant early exercise options that result in restricted stock when exercised, as explained in detail in the pre-IPO content on this website.
Options Versus Restricted Stock
Unlike stock options, restricted stock is never underwater, because it always has some value to you even when the stock price drops below the price on the date of grant. This may help you feel more of the wealth impact (and shareholder pain) of rises and falls in your company's stock price.
Options have more leverage for you in a rising market than restricted stock. You are usually granted many more options than you are in a comparable value of restricted stock (e.g. three options equal the value of one restricted share), so you can profit more from options.
Different Than Restricted Securities
Restricted stock is sometimes confused with the term restricted securities. This other technical term applies to stock that is not registered with the Securities and Exchange Commission (SEC) or to stock that is owned by a senior executive (i.e. a control person or affiliate) and is resold under SEC Rule 144 or another exemption.
What's The Restriction?
Traditionally, only executives and key employees received restricted stock. Now companies are making broader grants of restricted stock and RSUs instead of, or along with, stock options. The stock is "restricted" because you cannot sell it until you satisfy the vesting schedule, which can be contingent on your continued employment (i.e. time-based vesting) or on performance targets. A vesting schedule determines when the restrictions lapse.
In time-based vesting, you must work for a certain period before the restrictions on the stock lapse. For example, your restricted stock may vest in increments of 25% a year (the most common schedule). If dividends are issued, you typically receive them (even before vesting) whenever shareholders do. (Dividend equivalents can be issued for RSUs, but this is up to your company.)
Vesting could also, or instead, be performance-based or tied to company-specific goals (e.g. return on assets or market share gains) or stock market targets (e.g. if stock price exceeds grant date price by 25% for 30 straight days). Time-based vesting in some situations may be accelerated by similar performance targets or by certain events, such as a merger.
If you leave the company before the restricted stock award vests, you forfeit some or all of the granted shares. You keep the part of any grant that vested. As with stock options, you should check your plan for other details, such as treatment after retirement, disability, or death.
In 2019, Ayco surveyed 325 US companies that grant restricted stock or RSUs. The firm found that 60% use graded vesting (i.e. shares vest in increments over time) and 40% use cliff vesting (all shares vest after the vesting period). Among all vesting schedules, three-year cliff vesting (at 37% of the companies) is the most common.
|Companies Using Graded Vesting|
|Period until vesting||% of companies|
|33% per year (3 years)||37%|
|25% per year (4 years)||15%|
|20% per year (5 years)||1%|
|Uneven or staggered||9%|
|Companies Using Cliff Vesting|
|Period until vesting||% of companies|
|4- or 5-year cliff||5%|
Usually the shares are held in escrow or some type of custodial arrangement until vesting. Once the restricted stock has vested, you can resell it. The grant does not usually expire or have a term ending date, as options do, unless you have a performance-vesting provision with a timeframe.
Restricted Stock Units
Some companies grant restricted stock units (RSUs) instead of restricted stock. The two types of grants have many similarities (see the subsection on this site devoted to issues that are unique to RSUs). RSUs normally vest over time, as regular restricted stock does, but usually do not pay dividends and do not confer voting rights. The units typically are distributed as shares at vesting.
Depending on their design, some plans may have a tax-deferral feature, distributing the stock after you leave the company, at another date, or at a date you specify. RSU plans with deferral features need to avoid the traps for deferred compensation in Section 409A of the Internal Revenue Code.
Many experts predict (and surveys show) that if companies begin expensing the "cost" of stock options on their financial statements, restricted stock will gain popularity because stock options will no longer have more favorable accounting treatment. The move by major companies toward granting RSUs instead of options has accelerated this renewed interest. Grants of restricted stock may vary in features more than those of stock options, so understand the details (e.g. vesting).
Next Article: Taxation
At a grant of restricted stock you need to make immediate decisions about tax treatment. We discuss these concerns in Part 2 of this series.
Kate Victory is a Content Developer and Editor at myStockOptions.com. Bruce Brumberg co-founded myStockOptions.com and is its Editor-in-Chief.
Got another four minutes? Watch our popular video on the essentials of restricted stock and RSUs.
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