Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Restricted Stock

What it is:

Restricted stock is stock that the owner cannot sell immediately or under certain conditions.

How it works (Example):

People usually come to own restricted stock through an IPO or a merger. For example, let's assume that Company XYZ goes public. To reward certain key employees for their contributions to the company over the years it took to become successful, the board of directors gives them each 1,000 shares of restricted stock. These shares cannot be sold for 90 days after the IPO date. On day 90, the shareholder usually will owe taxes on the value of the shares if he or she received them as part of a grant. When the shareholder sells his shares, he also will pay capital gains tax on the profit.

Why it Matters:

The general motivation behind issuing restricted stock is usually to avoid having a large number of sellers in the market at the same time, which would reduce the value of the stock. For example, if all of those paper millionaires in our example tried to cash out at the same time, their rush to sell the stock would have the ironic effect of reducing the value of their shares. Accordingly, restricted stock carries more risk than unrestricted stock because the value of the stock may decrease before the owner is able to sell it. Restricted stock also can encourage key employees to remain with the company longer.