Rewarding Key Personnel: Restricted Stock or Options?

As I write this post, I am in the process of helping an early-stage client develop a stock-based compensation plan for a key officer. The principal choice was between a stock option and restricted stock.

A stock option is the right to purchase a specified number of shares at a specified price at some point in the future. The option typically “vests” over a period of years. The longer the individual stays with the company, the greater the portion of the option s/he has the right to exercise. At the end of the vesting period, the individual has the right to purchase all of the shares specified in the option.

With restricted stock, shares are granted to the individual immediately but are subject to “reverse vesting”. If the individual leaves the company, a specified portion of the stock is forfeited to the company, if the individual paid nothing for the shares. Or it is subject to repurchase by the company at the price the individual paid. The portion that is subject to forfeiture or repurchase declines to zero over a specified number of years.

When restricted stock is granted, the recipient signs, in addition to a stock purchase agreement, a Stock Assignment Separate from Certificate.  If, when the individual leaves, some shares remain unvested, the company at that time fills in the number of unvested shares, which then are forfeited or repurchased.

Many companies are choosing restricted stock over stock options, and that was the choice my client made.

• The company has so few employees that it sees little reason to incur the costs of implementing a tax-qualified stock option plan.
• The officer’s input as a shareholder will be valued by the company. (A holder of restricted stock generally is accorded rights of a shareholder, including the right to vote. A holder of a stock option does not have any shareholder rights until the option is exercised, i.e., when the shares are purchased.)
• Restricted stock is likely to be perceived as more valuable. If the price of restricted shares decreases over time, the shares still can have some value to the recipient. On the other hand, if the price of the company’s shares decreases below the option holder’s exercise price, the option becomes worthless.

Whatever form of stock-based compensation is selected, both the company and the individual should consult with their tax advisers before the grant takes place.

Related posts:

• Stock is Great – but Don’t Give It Away Too Quickly!
• How Can I Have Reverse Vesting in an LLC?

Photo credit: Michelle Meiklejohn

Dana H. Shultz, Attorney at Law  +1 510 547-0545  dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.