What “Restricted Stock” Really Means at Private Companies

Restricted Stock Isn't Always "Restricted Stock"

Terminology matters more than you think in private company equity compensation. Ask three people at a private company what "restricted stock" means, and you might get three different answers.

Someone in HR might be talking about RSUs. Someone in finance might mean actual shares on the cap table. And an employee might just be wondering why they can't sell the stock they already own.

The confusing part? They could all be using the same term to describe very different things.

In equity compensation, "restricted stock" can refer to three concepts: restricted securities, restricted stock awards (RSAs), and restricted stock units (RSUs).

At private companies, where ownership, vesting, taxes, and liquidity don't necessarily happen at the same time, understanding the differences is particularly important.

Fortunately, there's a fairly simple way to sort them out.

What's actually restricted?

• The ability to sell shares you already own? Those may be restricted securities.
• The right to keep shares already issued to you? That's generally an RSA.
• The right to receive shares in the future? That's generally an RSU.

Of course, these categories can overlap. An RSA may also be a restricted security under federal securities laws. Shares delivered when RSUs settle may also be subject to resale restrictions.

That's why the label alone doesn't always tell you the whole story.

Restricted Securities: You Own the Shares, But Can You Sell Them?

Here's the important thing about restricted securities: an employee may already own the shares. The restriction is generally about when the shares may be sold, not whether they've earned the shares.

At private companies, these restrictions are often related to securities laws. For example, Rule 701 allows qualifying companies to issue equity to employees and certain other service providers without registering the offering with the SEC. Shares issued under Rule 701 generally are restricted securities.

Imagine an employee who owns 10,000 fully vested shares of a private company. They've completed their vesting requirements, and the shares belong to them.

But when they ask to sell, the answer may still be no.

Why?

Securities laws. Rule 144 may provide a way to resell restricted securities after applicable holding periods and other requirements are satisfied. For securities of non-reporting companies (i.e., private companies), the holding period is generally one year. But satisfying legal requirements doesn't automatically make private company shares freely tradable.

Company restrictions. Private companies often have additional rules, including rights of first refusal, board approval requirements, and transfer restrictions in shareholder agreements.  It is not uncommon for a private company to impose a fee in connection with the transfer of private company shares.

No buyer. Even if a sale is legally permitted, there may simply be no market for the shares.

This is where employee expectations can get a little disconnected from reality.

An employee may reasonably ask, "If my shares are fully vested, why can't I sell them?"

The answer is that vesting and liquidity are two very different things.

For private companies, this is an important distinction to communicate. Saying employees own their shares may be accurate, but that doesn't mean they can readily turn those shares into cash.

RSAs and Early-Exercised Options: Ownership Comes First

Restricted stock awards work a little differently.

With an RSA, the employee generally receives actual shares at grant, but there's a catch. If they leave before satisfying the vesting requirements, the company may have the right to repurchase or forfeit the unvested shares.

In other words, the employee owns the shares, but the right to keep all the shares depends on satisfying certain conditions.

Because the shares are issued upfront, the employee becomes a shareholder immediately. Voting and dividend rights depend on the company's governing documents and award terms.

RSAs are particularly common at early-stage private companies, when share values may still be relatively low.

Another way employees can end up holding restricted stock is through the early exercise of stock options.

Some private companies allow employees to exercise options before they vest. When that happens, employees receive actual shares, typically subject to the company's right to repurchase the unvested portion if they leave.

The result looks a lot like an RSA. The employee owns shares, but the right to keep them is still tied to vesting.

Why the 83(b) Election Matters

Both RSAs and early-exercised options introduce an important tax consideration: the Section 83(b) election.

Here's a simplified example.

Imagine an employee receives 1,000 restricted shares when they're worth $1 each. Four years later, those shares are worth $10 each.

Without an 83(b) election, the employee generally recognizes ordinary income as the shares vest, based on the fair market value at each vesting date, less any amount paid for the shares.

With a timely 83(b) election, the employee instead recognizes income based on the difference between the fair market value when the shares are first transferred and the amount paid, if any, for the shares.

If the employee paid fair market value for the shares, the income recognized at transfer would be zero.

Making an 83(b) election and recognizing the income early can make a significant difference, particularly at early-stage companies where share values may increase substantially.

But there's an important catch.

The election generally must be filed with the IRS within 30 days of the share transfer. There is no extension.

And making an 83(b) election isn't without risk. If the shares are later forfeited or decline in value, the employee generally cannot recover any taxes paid because of the election.

As private company valuations increase, RSAs can become less attractive because employees may face a substantial upfront cost, including the associated income taxes, without having a way to sell their shares.

For stock plan professionals, these awards also require careful administration. Companies need to track actual share ownership, vesting, repurchase rights, and any 83(b) elections employees report having made.

Unlike RSUs, these shares generally appear as issued and outstanding on the cap table from the time they're issued, even while they're still subject to vesting.

RSUs: A Right to Future Shares, Not Yet Ownership

RSUs are different because employees don't receive any shares when the RSU is granted.

Instead, an RSU represents a contractual obligation to deliver shares or, sometimes, the cash equivalent in the future, subject to the award's terms.

Until shares are delivered, employees aren't shareholders and don't have voting rights. Some companies provide dividend equivalents, but those aren't the same as dividends paid to shareholders.

RSUs have become an important part of equity programs at later-stage private companies, particularly as valuations rise and stock options or RSAs become less attractive for certain employee populations.

One distinction that's easy to overlook is that vesting and settlement aren't necessarily the same event.

An employee may complete a service requirement, but that doesn't always mean shares are immediately delivered.

For private companies, this creates a practical challenge.

When RSUs settle in shares, employees generally recognize ordinary income based on the fair market value of those shares, even if there's no readily available market in which to sell them.

That means companies need to think about how employees will cover their income and employment taxes, and how withholding and reporting will be handled.

What About Double-Trigger RSUs?

Some private companies use RSUs subject to both time- and performance-based conditions (so-called “double trigger” RSUs) to help address this challenge.

Think of these awards as having two requirements, both of which must be satisfied, for the RSUs to vest. First, the employee must complete a service requirement (e.g., the time-based condition). Second, a qualifying event, such as an IPO or acquisition, must occur.

Completing the first requirement doesn't mean the employee owns shares. Both conditions generally must be satisfied before the award fully vests and shares are delivered.

A properly structured double-trigger arrangement can help avoid income and employment tax withholding obligations before a liquidity event, although the specific tax treatment depends on the award terms.

There's another consideration: timing.

Many double-trigger RSUs include a deadline for the qualifying event to occur. If the company stays private longer than expected, employees could lose awards even after completing their service requirements.

It's a good reminder that completing a vesting schedule and owning shares aren't always the same thing.

Where the Confusion Creates Real Problems

These distinctions may seem straightforward to experienced equity compensation professionals. But using the terms interchangeably can create problems across several areas.

Employee communications. An employee is told they've received "restricted stock" and assumes they're already a shareholder. In reality, they hold RSUs and won't own shares until settlement. That misunderstanding can affect expectations around voting rights, dividends, and liquidity.

Tax reporting. An employee receives an RSA but doesn't understand the significance of an 83(b) election until after the 30-day window has closed. Another employee assumes an 83(b) election is available for RSUs, even though no shares were transferred at grant. Both misunderstandings can have meaningful tax consequences.

Cap table management. Unsettled RSUs represent potential future share issuances, not currently outstanding shares. Confusing RSUs with restricted stock can create problems in capitalization reporting, dilution calculations, and shareholder records.

Liquidity events. One employee holds vested shares subject to transfer restrictions. Another holds unsettled RSUs. Both may say they have restricted stock, but the ability to participate in a tender offer or secondary transaction is very different, depending on the transaction structure and award terms.

Administration. RSAs and early-exercised options require tracking issued shares, vesting restrictions, and repurchase rights. RSUs require tracking vesting, settlement, share delivery, and tax withholding. Using the wrong terminology can create confusion about which processes apply and when action is required.

The Takeaway for Private Companies

Equity programs often evolve faster than the language used to describe them.

A company that began by issuing restricted stock to founders and early employees may eventually introduce stock options, early-exercise stock options, RSUs, or a combination of award types.

But employees may continue using "restricted stock" as a catchall term, even when the awards work very differently.

The goal isn't to eliminate the phrase. It's to make sure everyone understands what it means in the context of the company's equity program.

One practical place to start is with a terminology review.

Look at award agreements, offer letter templates, equity plan materials, and employee FAQs. Are the awards identified accurately? Do the materials explain when ownership begins, what conditions remain, when taxes may arise, and whether employees can sell their shares?

And are legal, HR, finance, payroll, and stock administration all using the same terminology?

Nobody needs another complicated equity compensation term. We already have plenty of those.

But getting this one right can make a real difference, especially at private companies where employees may wait years before seeing any value from their equity.

So the next time someone says "restricted stock," ask a simple question:

What's actually restricted?

The ability to sell? The right to keep? Or the right to receive shares?

That one question can clear up a surprising amount of confusion.

For more resources, visit the Private Company Stock Plans section on NASPP.com.