Issuance of restricted shares: Overview, definition, and example
What is the issuance of restricted shares?
The issuance of restricted shares refers to the process by which a company issues shares to an individual, such as an employee or insider, with specific restrictions attached to those shares. These restrictions may include limitations on the sale, transfer, or disposal of the shares for a certain period, or may be tied to performance conditions or milestones. The purpose of issuing restricted shares is often to incentivize employees, align their interests with those of the company, and retain talent by providing ownership in the business.
Restricted shares are typically issued as part of compensation packages, especially in startup companies or corporations looking to reward employees for their work or commitment to the company's long-term success. These shares can only be sold or transferred once certain conditions or restrictions are lifted, often based on factors such as continued employment or the achievement of specific business targets.
Why is the issuance of restricted shares important?
The issuance of restricted shares is important for several reasons:
- Employee Retention and Incentivization: Restricted shares provide employees with a stake in the company, which motivates them to work towards the company’s success. The restrictions often require the employee to stay with the company for a specified period, encouraging long-term retention.
- Aligning Interests: By giving employees or insiders a financial interest in the company, restricted shares align their interests with those of the shareholders. Employees are more likely to work towards increasing the company's value since their own wealth is tied to the company's performance.
- Tax Benefits: In some cases, restricted shares may have tax advantages for both the company and the employee. For example, employees may defer tax on restricted shares until the restrictions are lifted, or the shares vest, allowing them to potentially benefit from capital gains tax rates.
- Control and Liquidity: For the company, issuing restricted shares allows it to retain control over the ownership structure and limit the number of shares that can be traded or sold on the open market, ensuring that shares are not sold prematurely.
Understanding issuance of restricted shares through an example
Let’s say a technology startup, InnovateTech, is looking to attract a talented software engineer, Emma, to join their team. As part of her compensation package, InnovateTech offers Emma 5,000 restricted shares in the company. The agreement specifies that the shares will vest over a 4-year period, with 25% of the shares vesting each year as long as Emma remains employed at InnovateTech.
This means that:
- In the first year, 1,250 shares will vest and become unrestricted, allowing Emma to sell or transfer those shares if she wishes.
- In the second year, another 1,250 shares will vest, and so on, until Emma fully owns all 5,000 shares after 4 years.
During the vesting period, Emma cannot sell or transfer any of her restricted shares that have not yet vested. If Emma leaves InnovateTech before her shares are fully vested, she may forfeit the unvested portion of the shares, depending on the terms of the agreement.
This structure helps InnovateTech retain Emma's services and incentivizes her to contribute to the company’s long-term growth.
Example of issuance of restricted shares clause
Here’s how a clause related to the issuance of restricted shares might appear in an employee agreement or stock plan:
“The Company hereby grants to the Employee [5,000] restricted shares of the Company’s common stock, subject to the following terms and conditions: (1) The shares shall vest in equal installments over a four-year period, with 25% of the shares vesting on each anniversary of the Employee’s start date, provided that the Employee remains in continuous employment with the Company. (2) Unvested shares may not be sold, transferred, or otherwise disposed of until they have vested. (3) In the event that the Employee’s employment is terminated for any reason prior to the vesting of all shares, any unvested shares shall be forfeited. (4) The Employee acknowledges that the restricted shares are subject to the Company’s equity compensation plan and other applicable company policies.”
Conclusion
The issuance of restricted shares is a strategic tool used by companies to attract, retain, and incentivize employees or other key stakeholders. These shares not only provide employees with a financial stake in the company’s success but also serve as a retention mechanism, as the shares are typically subject to vesting conditions. For companies, issuing restricted shares helps align employees’ interests with those of shareholders, while also maintaining control over the ownership structure. Understanding the terms of restricted share agreements is essential for employees, as it governs when and how they can access the financial benefits of the shares they have been granted.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.