What is restricted stock and the most common restriction associated with it?

Restricted stock is stock of the company that is subject to certain contractual restrictions on its ownership. When company grants a restricted stock to its employees/independent contractors, they receive the actual stock of the company and become owners of record, but their ownership and accordingly the freedom to use it as they want is not absolute.

 

The common restrictions for a stock in a startup entity are:

 

·        Restriction on transfer or resale. First of all, the stock cannot be freely trade if it is not registered with federal and state regulatory authorities and startup’s stock is usually not. Second, even if applicable exemption from federal and state laws exist, partners in a small entity work closely with each other and do not want to deal with unknown third party.

·      Vesting period. In order to retaining the talent for longer and also to give incentive to employees to turn the business into a profitable and successful one, the employers usually impose vesting on shares. The vesting can be time-based, meaning the ownership will vest during a certain period of time (2 to 4 years are being common), or performance-based, meaning the ownership will vest upon the achievement of some milestones. Vesting also helps to avoid the situation when a person lives the company shorty after receiving the award and continues to hold a chunk of its equity. If am employee quits before the stock fully vests, the company will have the right to repurchase unvested shares. The repurchase price for unvested shares is typically the original price of it when granted that is usually minimal

 

Restricted stock is usually awarded to the founders of the company and employees at the early stages of business development. At that period the market value of the stock is minimal which allows parties to get it for nominal price. At the later stages of company development, market value of the stock may grow, which makes it expensive for the interested people to buy. If the company grants it for free, the receiver will recognize taxable income and will have to come up with money to pay taxes while the stock is totally illiquid and no sales proceeds to cover taxes from.

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