What is Restricted Stock?

Restricted stock is arguably the most straightforward form of equity compensation because it provides the recipient with fully-issued stock. This means the recipient owns the stock outright and possesses the relevant stockholder rights for voting, dividends, etc. This stock, however, is considered “restricted” because it is typically subject to limitations such as non-transferability and a vesting schedule providing that if the recipient fails to meet certain conditions the recipient will forfeit some or all of the shares.

Restricted stock is also among the most tax-advantaged forms of equity compensation. This is because with the 83(b) election properly filed, the recipient can include the value of all the restricted stock – even the portions that are subject to vesting – in the recipient’s income as of the time of acquisition. This often means the recipient recognizes no income because the restricted stock is generally issued at the fair market value.

Many founders wonder though why restricted stock isn’t given for every equity award. Despite its advantages, restricted stock is typically only appropriate for certain early stage companies for two main reasons involving issues of (i) control and (ii) an increasing fair market value.

In terms of control, founders should remember that unlike other forms of equity compensation, restricted stock means the recipient is given outright ownership of the stock, including voting power, at or around the time of grant. As a result, in some founders and other decision makers at the company may not want to grant significant amounts of restricted stock because they don’t want to inadvertently tip the scales of voting control.

In other cases, when the price per share becomes too high then it may not be financially feasible or sensible for equity compensation recipients to receive restricted stock. In a startup's early days, the shares are usually valued close to par value, usually of around $0.00001 per share, because little or no money has been raised or generated as revenue. When a startup is issuing thousands or millions of shares to recipients, a price per share at or around $0.00001 per share is relatively negligible; for example, even 5,000,000 shares at $0.00001 per share is only $50, an amount that virtually all recipients are willing to risk. But when the price per share creeps upwards after raises and revenue generation, then even a price of a penny ($0.01) can quickly make restricted stock untenable; those same 5,000,000 shares now cost $50,000 and for many people that is too much money to risk for stock that is subject to restrictions.