What is a Stock Restriction Agreement?
Office with multiple displays showing stocks

In today's corporate world, there are many ways for employees to receive compensation for their work. Apart from actual cash remuneration, one popular method of rewarding employees is to give them stock.

What is a Stock Option?

A stock option is a benefit that enables employees to purchase stock shares within a company at a predefined price if they choose to do so. For example, if Company X has 2 million shares worth $2 apiece, but allows its employees to buy the stock at $1.50 per share, then the company's employee stock option would be discounted at a rate of $0.50 per share. Stock options are beneficial to employees because they can enjoy a higher return on investment than an outside investor would if the company's shares increase in value.

What is a Restricted Stock?

Restricted stock is a form of a stock option where a company commits to giving an employee stock after specific requirements are fulfilled during a set length of time. The shares are considered restricted because they are subject to a vesting schedule, which can be based on performance goals, length of employment, or other specific types of milestones. The vesting period can last several years and during which the restricted stock units (RSUs) cannot be sold. Upon vesting, the IRS views such restricted stock as taxable income, and a portion is withheld to pay income taxes. The rest of the shares are for the employee to sell at their discretion. Startup companies often use a restricted stock compensation strategy, but with the accounting scandals like Enron in the mid-2000s, RSUs have become a popular choice over stock options.

What is a Stock Restriction Agreement (SRA)?

A stock restriction agreement (SRA) is a legal contract made between a company and its founders for an allotment of unvested shares of stock with certain restrictions on when it can be sold. An SRA is intended to safeguard a developing company's growth by guaranteeing continued founder involvement and deterring a premature equity sell-off. The objective of an SRA is to provide an incentive to the founders to continue contributing their time and talent toward the company's mutual success.

Equity ownership in the form of unvested stock shares is a common form of compensation divvied up between founders during a company's startup, when cash and other capital can be scarce, having been invested into the venture. To ensure all founders maintain a committed business relationship with the company for a set period, the SRA outlines a timetable for when the unvested stock shares become available for sale. The sale is typically under a graded vesting schedule.

A standard graded vesting schedule would be 25% a year over four years and may also be contingent upon the achievement of specific milestones such as a product launch, earnings per share (EPS) goals, or other performance metrics and financial targets. If the founder leaves or is terminated from the company before completion of the vesting schedule, the remaining unvested shares are forfeited. Additionally, the company usually retains the right to repurchase the unvested shares for a certain amount if the founder terminates their relationship with the company. However, once the founder has remained with the company for the entire time set within the vesting timeframe, then the stock becomes free from any repurchase rights held by the company and is therefore vested.

The Securities & Exchange Commission (SEC) regulations that govern the trading of restricted stock are outlined under SEC Rule 144, which describes the registration and public trading of restricted stock and the limits on holding periods and volume. Founders looking to enter into an SRA should consider retaining an attorney since such agreements require a highly specialized understanding of tax and securities regulations.

The blog posts provided on this website do not, and are not intended to, constitute legal advice; instead, all information, content, and materials available on this blog are for general informational purposes only.

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