Introduction:
Apart from the salary, companies provide several kinds of perks to their employees to attract and retain talent. These might include health insurance benefits, vacation packages, shopping vouchers, etc. Another common benefit that large companies provide to their employees is some form of equity compensation, i.e., shares in the company.
Equity compensation can be offered in two forms – Restricted Shares and Stock Options. Each has advantages and disadvantages, and knowing which is essential to reap maximum rewards. This article will discuss the meanings and differences between restricted shares and stock options. Continue reading.
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What are restricted shares?
Restricted shares are the more straightforward form of equity compensation. No transaction or stock pricing is involved here. Instead, the company simply pledges to provide an employee with a certain quantity of stocks if conditions are met. For example, a company can issue restricted shares to employees who have met specific performance criteria or have been associated with the company for a specified period.
As an employee, once you complete the required criteria, you’ll receive restricted shares from your company in actual shares or cash equivalent to their market price. Whether to provide actual shares or cash equivalent usually rests with the company. But in some cases, the employee can also get to decide.
However, this benefit might depend on a vesting period as per the company’s policy. The vesting period is when an employee must wait before claiming the allocated shares. For example, suppose a company provides 200 restricted shares to its employees with a vesting period of three years. The employee must complete at least three more years of service to access the allotted shares.
What are stock options?
A stock option is another form of equity compensation wherein employees can purchase up to a certain quantity of company shares at a determined price within a time window. However, whether they want to purchase the shares is just an option for them and not an obligation.
For example, upon meeting a specific performance criterion, your employer may ask you to buy up to 1000 stocks of your company at Rs. 100 each in two years. The market value of each stock, however, is Rs. 200. So, in this case, you might get the shares at half their market price and make handsome returns when you resell them.
Note that if you fail to exercise your stock option within two years, you won’t be able to do so after that.
Restricted shares vs. stock options
As you know, both restricted shares and stock options are forms of equity compensation. However, they both have a few advantages and disadvantages. The table below depicts a comparison between restricted shares and stock options for a better understanding:
| Characteristics |
Restricted shares |
Stock options |
| Allotted |
Companies allot the shares |
Employees purchase the shares |
| Grant date |
Dated on issuance |
Dated on issuance |
| Exercise price |
Not applicable |
As decided by the company |
| Action |
The beneficiary won’t have to do anything. Shares are automatically allotted |
The beneficiary has to exercise the stock option and purchase the shares |
| Risk involved |
No risk involved as the employee won’t have to pay anything |
Certain risks are involved |
| Voting rights |
No voting rights |
Voting rights are granted once an employee exercises the stock option |
| Shareholders rights |
Shareholders get only restricted rights |
Full shareholders' rights are given |
| Dividends |
No dividend is paid |
Dividends are paid |
| Mode of benefit |
Shares or cash equivalent |
Shares |
| Taxation |
Taxes depend on the holding period of shares after vesting. Furthermore, it varies for listed and unlisted companies |
Taxes depend on the holding period of shares after vesting. Furthermore, it varies for listed and unlisted companies |
| Suitable for |
More suited for employers and employees at larger, established companies |
More suited for employers and employees at start-ups and early-stage companies |
Conclusion
Both restricted shares and stock options have pros and cons. Restricted shares are a less risky option as they require no financial transaction. The employees can enjoy a steady income, albeit with very limited rights. On the other hand, stock options offer potentially higher gains but with additional risk. If given a choice, you must consider your future plans, financial goals, and the company’s growth prospects before choosing between the two.
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