Definitions

Restricted stock

Restricted stock

Restricted stock, also known as letter stock or restricted securities, refers to stock of a company that is not fully transferable until certain conditions have been met. Upon satisfaction of those conditions, the stock becomes transferable by the person holding the award.

Another type of restricted stock is a form of compensation granted by a company. Typically, the conditions that allow the shares to be transferred are a period of time, when they vest. However, those restrictions can also be some sort of performance condition, such as the company reaching earnings per share goals or financial targets. Restricted stock is becoming a more prominent form of employee compensation, particularly to executives. It has come to prominence as stock options have fallen out of favor after the perceived excesses of the stock market in the early 21st century.

Valuation of Restricted stock

Data from real-world transactions play a key role in valuing illiquid assets, such as restricted stock and warrants. Just as real estate agents use the selling price of other homes in a neighborhood to help determine the asking price of a home that is just going on the market, so too similar sales of illiquid assets are used as a benchmark for valuation of restricted securities.

Several other factors influence the valuation of restricted securities, including:

  • The nature and length of the restriction;
  • The transferability of the restricted securities;
  • The underlying financial strength of the company;
  • Certain rights attached to the restricted securities, such as registration rights and liquidated damages;
  • The ability to borrow shares of the company for hedging;
  • The availability of publicly traded option contracts on the issuer’s stock;

Because they are illiquid, such assets typically sell at a discount from the market price of their unrestricted counterparts. Relevant real-world transactions of restricted stock give the best precedents for determining applicable discounts to apply to particular restricted securities.

USA

Under the securities laws, these conditions are either registration with the SEC, or fitting into one of the securities exemptions for resale, such as Rule 144.

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