The Difference Between Restricted and Controlled Stock

Learn the difference between these securities, and how they are used by businesses to grant ownership

Securities can take various forms, and each has certain benefits, drawbacks, details, and applications. Knowing the difference between securities used strictly as employee compensation or those that give controlling interest to partners helps a business achieve unique objectives.

Restricted stocks come in two forms—one giving the holder voting rights immediately, and the other holding back these rights based on a vesting schedule.

Controlled stock, conversely, is a stock that is held by a business affiliate—not necessarily an employee. They are used when an organization needs to raise capital or issue payment in exchange for some controlling interest in the business.

One thing ties all of these securities together, and that is ownership. When a business does well, the individuals or entities that hold these securities benefit as well.

Let’s take a look at what distinguishes these investment vehicles, and how each can be deployed.

Restricted stock as executive compensation

Restricted stock is typically used as an award to motivate executive-level employees by providing them equity; publicly traded companies give it as a form of compensation. The awards are subject to a vesting schedule that is determined by the company, which may be performance-based or tenure-based. Usually, individuals must still be employed by the issuing company to receive the stock on the vesting date, and this vesting schedule prevents premature selling that may negatively affect the share price.

One difference between restricted stock and stock options is that restricted stock almost always has worth at the time it is vested. For that reason, employees usually prefer receiving restricted stock rather than stock options.

At the time of vesting, the employee is subject to income tax for the face amount of the stock. They then also receive voting rights and dividend rights. Restricted stock is non-transferrable and can only be traded in compliance with specific SEC regulations—and because it is awarded to executives within the company, it is subject to insider trading laws.

In essence, restricted stock serves as another option for employers looking to offer compensation and benefits over and above something like a traditional 401(K). It further ties the employee’s performance and tenure to the company, often building loyalty.

Restricted stock units and restricted stock awards are two variations of restricted stock

restricted stock unit, or RSU, is a promise by the issuing company (employer) to the employee to grant shares of company stock in a specific amount at a certain date. No voting rights are given with an RSU, as it is simply a promise to the executive that shares will be granted.

restricted stock award is an actual grant of stock and comes with voting rights because the employee actually owns the stock once it is awarded. In both cases, the taxable amount of the stock is the fair market value on the date the stock is received or vested, minus its original exercise price.

Another difference between RSUs and restricted stock awards lies in redemption. In most cases, restricted stock awards cannot be redeemed for cash, whereas restricted stock units can be redeemed at vesting.

How restricted securities differ from restricted stock

As mentioned, restricted stock is given to executive employees as compensation for time with the company or reaching specific performance benchmarks. Restricted securities, however, are securities that are sold in a private sale that is unregistered. They are often received from a private placement offering, a Regulation D offering, or an employee stock benefit plan. They may also be obtained in exchange for startup money or professional services performed for the business. They can only be sold in the marketplace under certain conditions.

A restrictive legend must be visible on a restricted security, and a transfer agent is the only entity who may remove that legend—which can only be done with the consent of the issuer. Once the legend is removed, the security can then be sold on the marketplace. When looking to acquire restricted securities, it is advisable to contact a lawyer specializing in securities law. This helps ensure you understand what can and cannot be done, and whether acquiring the security is in your best interest.

What control stock is and what it means

An affiliate of the company holds control stock. That affiliate may be a high-level executive, director, or substantial shareholder. In this case, “control” means exactly what it sounds like. The holder of the control stock has a say in how the company is managed and can affect policy directives. These control measures may be through a contract, by virtue of voting rights attached to the stock, or dictated in another way.

While control stock may not be restricted in the hands of this individual or entity, it could be treated as restricted stock if purchased by another person or entity.

Executive stock options are used to attract and retain top talent

RSUs and restricted stock options are an excellent way to create a sense of ownership among executive-level employees and motivate them to hit performance benchmarks. Restricted securities may be offered as part of an employee benefit plan, but they have other implications when acquired by another individual or entity.

Controlled stock provides a level control to an organization’s business affiliate. This may be useful for businesses seeking startup or expansion capital, or those looking for a non-cash method of paying for professional services.

It’s important to understand the benefits that will motivate and keep your business’s top employees, and Lindberg & Ripple can help you devise solutions that accomplish your goals. Contact us for more information on designing a benefits package that works for your organization.

This information is obtained from sources that are believed to be reliable but we make no guarantees as to its accuracy. This material is for educational purposes only. Educational material should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney, tax advisor and plan provider. By accessing any links above, you will be connected to third party web sites. Please note that Lindberg & Ripple are not responsible for the information, content or product(s) found on third party web sites. Investments in securities involve risks, including the possible loss of principal. When redeemed, shares may be worth more or less than their original value. Diversification does not ensure a profit or protect against loss in a declining market. Securities and Investment Advisory Services Offered Through M Holdings Securities, Inc. A Registered Broker/Dealer and Investment Adviser, Member FINRA/SIPC. Lindberg & Ripple is independently owned and operated. # 3333680.1