Specific Types of Equity Compensation: Restricted Stock and Restricted Stock Units

Jeff Storch | 11.02.21

The discussion of equity compensation below describes two common types of equity compensation and how these specific types of awards are typically structured. However, employers have the freedom to structure equity compensation with different terms based on their business needs and objectives. For simplicity, the discussion focuses on stock but the concepts below generally can apply to all types of equity.

For a general overview, please see our post on equity compensation.

Restricted Stock

Restricted stock is a grant of stock to employees that is subject to certain restrictions. On the grant date, employees become the owners of records of the shares and have voting, dividend, and other stockholder rights. However, the shares are non-transferable and subject to forfeiture until the restricted stock vests (meaning, until the restrictions lapse). Restricted stock customarily vests when there is either (or a combination of):

• Completion of specific time-based employment service requirements (time-based vesting).
• Achievement by the company and/​or the employee of certain performance-based conditions (performance-based vesting), such as annual revenue or net income targets for the company.

If the vesting conditions are not satisfied, the shares are forfeited.

The shares are fully issued at the time of the grant. The shares ordinarily have no purchase or exercise price and provide immediate value to the grantee. Therefore, the awards have no risk of going ​“underwater” (this occurs when the fair market value of the stock underlying a stock option is less than the exercise price of the option). Restricted stock is considered a transfer of restricted property at the time the award is made which means that holders can elect to be taxed on the grant date under Internal Revenue Code (Code) Section 83(b) (generally a tax-advantaged election for the holder, although subject to the risk of forfeiture of the shares). If a Code Section 83(b) election is not made, the holder is taxed when the shares vest (if they are forfeited, there will be no tax).

Restricted Stock Units

Restricted stock units (RSUs) are awards that represent a promise to transfer shares of a company’s stock in the future if certain vesting criteria are met, but no actual stock is transferred at the time of initial grant. The RSUs ordinarily have no purchase or exercise price. They do not represent actual ownership interests in the underlying shares. After vesting, RSUs are customarily settled in stock but may also be settled in cash. If settled in stock, the shares generally will be subject to certain restrictions, as with restricted stock.

Like restricted stock, RSUs normally are subject to time-based or performance-based vesting and are forfeited if the vesting conditions are not met. Because holders of RSUs are not the actual owners of the underlying shares, they are not entitled to the dividend, voting, or other stockholder rights until the RSUs vest and the shares are transferred to them. Many companies, however, accrue ​“dividend equivalents” on RSUs during the vesting period so that holders receive the amount (in cash or shares) that they would have received in dividends if they had been the owners of the underlying shares.

Because the grant of RSUs is the grant of a promise and not a grant of restricted property, RSUs are not subject to taxation until the underlying shares vest and are delivered. If the underlying shares are not transferred to the holder of the RSUs within a short period of time after vesting, the delayed transfer may subject the holder to adverse tax consequences under Code Section 409A.

Our upcoming post will discuss phantom stock and stock appreciation rights.