Stock Option Plans, Restricted Stock, Phantom Stock and Other Incentive Plans for Closely Held Businesses
Article #4 – Restricted Stock Plans
This series of articles explains how restricted stock, stock options, cash plans and phantom stock really work for closely held companies, and what their real value is for the company and the employee.
The articles in the series are:
2. Equity Plans – Stock Options and Restricted Stock
3. Stock Option Plans
4. Restricted Stock Plans ◄You are here
5. Company Buy-Back and Repurchase of Stock Options and Restricted Stock
6. Cash Plans, Phantom Stock Plans and Stock Appreciation Rights
7. Summary and Plan of Action
Where You Are in the Series
In this article #4, I explain how you use restricted stock plans to reward and encourage employees. In the previous Article #3 – Stock Option Plans I introduced stock option plans.
In Article #2, Equity Plans – Stock Options and Restricted Stock I introduced ten basic concepts for all equity plans, including restricted stock plans. You should understand the ten basic concepts before moving on to this article.
Basics of Restricted Stock
Restricted stock plans work best for a small, select number of employees. These people are high level management; they are not rank-and-file employees. Think of restricted stock plans as one-off deals for individual employees.
From my perspective as a lawyer there are many differences between a stock option plan and restricted stock. But for you, the business owner, the primary difference is price and convenience. As between an option plan and restricted stock, restricted stock usually costs less and is easier to administer because less paper is involved. Further, if the restricted stock plan requires a California filing, the filing fee usually will be less than for an option plan.
Pricing of Restricted Stock
With restricted stock plans, you grant stock directly to the employee. You directly issue all of the stock to the employee at the then-current fair market value of your company’s stock (determined by the board of directors in its reasonable discretion).
If the employee cannot pay the entire purchase price for shares up-front, you can accept a promissory note from the employee. If you want to give the stock for free to the employee, the gift will be ordinary income to the employee, that is, the employee will have ordinary income for tax purposes equal to the fair market value of the stock.
Vesting of Restricted Stock
The employee’s restricted stock likely will be subject to vesting, similar to options. For restricted stock (unlike options), vesting really refers to the lapse of your (the company’s) right to repurchase the stock. That is, when restricted stock is said to vest, it really means that the company’s right to repurchase the stock has lapsed. This is a technical difference between restricted stock and option. You can ignore these technical points, however, because the outcome should be the same whether you use restricted stock or options.
Repurchase of Restricted Stock
The key to restricted stock is that you retain the right to repurchase the stock if the employee ever leaves the company. Using the closely held company model that I’ve developed, you would repurchase 100% of the stock if the employee leaves the company, and you would pay a fair price for the stock. I discuss this at length in my next article, Company Buy-Back and Repurchase of Stock Options and Restricted Stock.
You should hire an attorney to help you with your restricted stock plan. It’s expensive to have me fix a bad plan; it’s cheaper to do it right the first time. If you want to read more try my main page, Business Lawyer. From there you can link to other pages and articles of interest.