Restricted Stock vs Restricted Stock Units: Key Differences Explained

Restricted stock and restricted stock units (RSUs) are forms of equity compensation used by companies to incentivize employees. While they may seem similar, understanding their distinct characteristics is crucial for both employers and recipients to make informed decisions about compensation packages.

This article explores the key differences between these two types of equity awards, focusing on aspects like vesting schedules, tax implications, and market value impacts.

Nature of the Grant

Restricted stock involves issuing shares to employees at the time of the grant, subject to vesting conditions. This means employees are shareholders from the start, with limited rights until vesting is complete. These rights often include potential dividends and voting privileges, which can influence corporate decisions.

RSUs, on the other hand, are a promise to deliver shares or their cash equivalent in the future, contingent on vesting conditions. Employees do not have shareholder rights until the RSUs vest and settle. This distinction affects their ability to participate in corporate governance during the vesting period. Companies must recognize compensation expenses for both restricted stock and RSUs over the vesting period, though the timing and method of expense recognition differ.

Vesting and Settlement

Vesting schedules, which dictate when an employee earns the right to equity, are often spread over several years or tied to performance metrics. For restricted stock, once vesting conditions are met, the shares become fully owned, and the employee can hold or sell them as desired.

RSUs add complexity in their settlement. Upon vesting, RSUs convert into shares or cash, triggering tax implications. The value of RSUs at vesting is taxed as ordinary income and subject to payroll taxes. Restricted stock is also taxed at vesting, but employees can opt for an 83(b) election to pay taxes on the grant value instead of the vesting value, potentially reducing tax liability if the stock appreciates.

Dividend and Voting

Restricted stockholders typically receive dividend rights immediately, even if shares are unvested. These dividends are taxed as ordinary income unless an 83(b) election is made. RSUs do not provide dividend rights until vesting and settlement. Some companies, however, offer dividend equivalents for RSUs, which are taxed as ordinary income upon vesting.

Voting rights also differ. Restricted stockholders often gain voting rights from the grant date, allowing participation in corporate governance. RSU holders only receive voting rights after vesting and conversion into shares, limiting their influence during the vesting period.

Tax Handling

Restricted stock is taxed at vesting, with the fair market value treated as ordinary income. The 83(b) election allows employees to pay taxes on the grant value, which can be advantageous if the stock appreciates but carries the risk of forfeiting payment if vesting conditions are unmet. RSUs are taxed at vesting without the 83(b) option, potentially increasing the tax burden by adding the value to taxable wages. Stock appreciation after vesting is subject to capital gains tax, providing a potential tax advantage over time.

Transferability

Restricted stock is generally non-transferable until vesting conditions are met, ensuring alignment with company goals. After vesting, shares can be transferred, though insider trading regulations or lock-up periods may apply. Similarly, RSUs are non-transferable until vesting. This structure helps retain talent, as employees must remain with the company to fully benefit. Once RSUs vest and convert to shares, transferability becomes possible, though restrictions may still apply for executives or insiders.

Market Value Implications

For restricted stock, the market value at grant impacts perceived award value. Stock appreciation during the vesting period benefits employees, aligning their interests with shareholders. However, if the stock underperforms, the compensation value decreases. RSUs, by contrast, offer a more predictable market value at vesting, which aids financial planning. While RSUs may lack the immediate appreciation potential of restricted stock, fluctuations in stock price still influence their perceived value. Companies must consider these factors when designing equity compensation plans to effectively motivate and retain employees.