Restricted shares and stock options are two types of equity compensation awarded to employees, each with unique conditions.
Restricted shares can be in the form of restricted stock units (RSUs) or restricted stock awards. Both require vesting, meaning they are subject to certain conditions before they can be sold or transferred.
Restricted shares and stock options are two different forms of equity compensation provided to employees. Once converted to actual shares, restricted shares confer shareholder rights, including voting rights, upon the employee. Employees who receive these awards own the stock outright when it’s awarded and have all shareholder rights, such as receiving dividends and voting at annual meetings. However, the company may reserve the right to buy back unvested shares if the employee leaves the company. The Securities and Exchange Commission (SEC) regulates the trading of restricted stock under SEC Rule 144.
Stock options represent a right to buy (or sell) shares at a specific price, known as the exercise price, at some future date. They do not involve a transfer of ownership. An employee may profit by the difference between the exercise price and the actual market price. Stock options are often granted by startup companies to motivate employees to help the company grow. They are normally restricted by a market standoff provision, which restricts the sale of shares for a certain time after an initial public offering (IPO) to stabilize the market price of the stock. Stock options provided as compensation by a public company often have a vesting schedule, preventing people from leaving a company after only a short time with shares that could become valuable. A stock option involves a specific transaction date, an exercise (or strike) price, and the number of underlying shares involved. One stock option contract represents 100 shares of stock. The value of a stock option depends on the difference between the exercise price and the market price of the underlying stock. It’s important to familiarize yourself with the differences between restricted shares and stock options because the features of each can require different planning for the benefit you may receive. Here are the key differences: – Issuance: Restricted shares are granted, while stock options are purchased. – Value: Restricted shares have a value based on the fair market value, whereas stock options have a value based on the difference between the exercise price and market value. – Variations: There are restricted stock units and restricted stock awards, as well as non-qualified stock options and incentive stock options. – At Vesting: Shares are typically deposited into a brokerage account with no action needed from the employee, whereas the employee must exercise the option and decide whether to hold or sell. – Risks: Restricted shares are less risky because the employee receives stock with fair market value, while stock options are more risky because their value may be zero if the market price is equal to or less than the exercise price. – Taxation: Gains on restricted shares are taxed as ordinary income in the year they vest (except with an 83(b) election), while non-qualified stock option (NSO) gains are taxed as ordinary income whether held or sold, and incentive stock options (ISOs) may be taxed as ordinary income, long-term capital gains, or according to the alternative minimum tax. When shares are restricted, it means they cannot be sold until the conditions of restriction are met. For instance, restricted shares given as a form of compensation usually come with a vesting schedule that establishes a period (or periods) of time that must pass before shares can be sold. Additionally, specific financial milestones may need to be met before employees may sell their shares.Understanding when to exercise stock options is crucial for maximizing profits. Generally, you should exercise stock options within the time frame specified by the option contract and when the market price exceeds the strike price. This allows you to sell the shares at a higher price than your purchase price, thus realizing a profit.
The choice between stock options and restricted stock can be subjective and depends on your perspective. Restricted shares are often seen as less cumbersome because they are automatically deposited into a brokerage account once vested, without the need for you to purchase them. In contrast, stock options require more effort as you must exercise them and buy the underlying shares, which can also have different tax implications. It’s important to note that some public companies offer stock as a form of compensation to their employees, in addition to their salary. This is intended to motivate employees to contribute to the company’s success. Such compensation can come in the form of restricted shares or stock options. Gaining a clear understanding of how these forms of compensation work and their associated implications can lead to significant financial savings in the long term.
