Restricted Stock Shares, Always a Great Tool, Sometimes - New Article by Dan Walter

Dan Walter has a new monthly series covering different equity compensation instruments, at the Payscale "Compensation Today" blog.  Here's his most recent )past articles have covered ISOs and NQSOs

Equity Compensation – Restricted Stock Shares, Always a Great Tool, Sometimes

02/07/2013

Participants
in RSS plans become instant shareholders. Most companies even provide RSS
holders with the same voting and dividend rights held by owners of unrestricted
stock. While the participants receive many of the same privileges as regular
shareholders the stock can be forfeited by the participant or repurchased by
the company if the individual does not meet their award conditions. This is
referred to as the stock being “subject to a substantial risk of forfeiture.”
This can be both a blessing and a curse to the participant.

On
the positive side, stock that is subject to a substantial risk of forfeiture
does not trigger ordinary income and associated tax withholding until the
restrictions lapse. This means the individual can control real stock without
immediate taxation. On the downside, the stock is essentially only on loan
until vesting has been achieved. If the participant leaves the company before
the shares are vested, or if performance goals are not met, the company can
usually “repurchase” the shares at the same price the individual paid for them.
Since this amount is almost always $0.00, this can be a bad deal for the RSS
holder.

RSS
income and taxation generally falls under IRC 83. The restricted status of
these awards offers unique tax planning possibilities. Remember that a key
feature of stock
options, allows individuals to choose when to exercise their vested options
and be hit with associated income and taxes. RSS awards become taxable when
they vest. On the date of vest, the restrictions lapse and the current value
becomes ordinary income that may be subject to tax withholding. This lack of
flexibility can frighten potential participants. But, the IRS allows participants
to ignore this delayed income event by filing an 83(b) election. This election
allows income and taxes to be based on the spread at the time of award. There
are rules and restrictions regarding 83(b) elections, but in the right
circumstances they can be very powerful tools. Used incorrectly, the results
can be extremely detrimental.

Companies
usually award RSS to very early employees or to executives or directors in
established public companies. A key reason for using this tool at private companies
is their exemption from IRC 409A, the deferred tax rules. Private companies are
not required to determine a value for the company stock under IRC 409A when
using RSS. Key reasons for public companies to use RSS include helping
executives meet share ownership guidelines and providing a tool that delivers shareholder
dividends. RSS use has a mixed reputation. Shareholders like the fact that RSS
are less leveraged than stock options, but they hate the fact that value is
built in. Since they cost nothing to the participant, RSS awards have some
value even if stock prices go down.

It
should be noted that over the past 15 years many companies have moved from RSS
to another type of FVA, Restricted Stock Units (RSUs), which will be covered in
my March 7, 2013 post. FVAs are excellent retention tools. They provide a safe
and steady component to an equity compensation package that may otherwise seem
capricious and volatile. While RSS are a tool that does not work for every
occasion, they are something that early-stage start-ups and successful public
companies should have at their call. These instruments have limited uses, but
when they are great, they are better than anything else.

Note:
RSS awards allow far more flexibility than be discussed in article of this
length. This is part of a series of posts on equity compensation instruments
that will run the first Thursday of every month for the foreseeable
future.  Please reach out to me directly
if you have any questions or can’t wait for future postings on a specific topic.