Restricted Shares vs. Stock Options: An Overview

Restricted shares and stock options are both forms of equity compensation, but each comes with some conditions.

  • Restricted shares are awarded outright, and their owner has the same rights and privileges as any shareholder. They may receive dividends and vote at the annual meeting, for example. However, the shares may be vested, and the company may reserve the right to buy back unvested shares if the employee leaves the company.
  • Stock options are the right to buy a certain number of shares at a certain price in the future. The employee will get a windfall if and when the company's stock price exceeds that price. Stock options, like restricted shares, are often vested.

Both are awarded to motivate employees, but restricted shares are most often granted by established companies while stock options are popular with startups.

Restricted Shares

Restricted shares are, as noted, an outright award of equity ownership in a company. They are most common in established companies that want to motivate employees by giving them an equity stake.

However, they are usually vested. That is, when restricted shares are given to an employee, it is on condition that the employee will continue working at the company for a number of years or until a particular company milestone is met. This might be an earnings goal or another financial target.

Such shares are often granted in stages, each with its own vesting date or milestone attached.

The shares may be restricted by a double-trigger provision. That means that an employee's shares become unrestricted if the company is acquired by another and the employee is fired in the restructuring that follows.

Insiders are often awarded restricted shares after a merger or other major corporate event. The restrictions are intended to deter premature selling that might adversely affect the company.

An executive who leaves the company, fails to meet performance goals, or runs afoul of SEC trading restrictions may have to forfeit their restricted stock.

Stock Options

Employee stock options are a promise of future profits that might or might not pan out. They are often granted by startup companies that have not yet gone public and want to motivate employees to get the company off the ground.

Stock options do not involve a transfer of ownership. They are a right to buy shares at a specific price at some future date. The employee profits by the difference between the option price and the actual market price.

Stock options are normally restricted by a market standoff provision, which restricts the sale of shares for a certain period of time after an initial public offering (IPO) to stabilize the market price of the stock.

Key Takeaways

  • Restricted shares and stock options are both forms of equity compensation that are awarded to employees.
  • Restricted shares represent actual ownership of stock but come with conditions on the timing of their sale.
  • Stock options are the right to buy a certain number of shares at a certain price in the future, with the employee benefiting only if the stock price then exceeds the stock option price.