Equity Incentives

Difference between options and restricted stock

"Restricted Stock" is a term often used to refer to shares of stock of a company that are subject to vesting requirements. The shares are purchased and owned by the shareholder. The shareholder can vote the shares. If a dividend is paid on the shares, the shareholder is entitled to be paid the dividend. However, the shares are subject to vesting. However, if the shareholder ceases providing services to the company—as an employee, consultant, advisor or otherwise—the company has the right to get back any of the shares that were not then vested (typically be paying the shareholder back the original purchase price paid for the shares). With time-based vesting, this means that the percentage of the shares that the company has the right to purchase decreases over time. This is sometimes referred to as "reverse vesting" in order to describe the contrast with vesting of options where the number of shares the option holder is entitled to purchase increases over time/as they vest.  

A stock option is a contract between the company and an employee, consultant, advisor or other service provider. It gives the individual the right to buy a certain number of shares of stock at a fixed price, called the exercise price. The right to exercise the option will vest—typically over time. So initially, the holder cannot exercise any of the shares, but the number of shares that become exercisable will increase over time as long as the individual continues to provide services to the company.

The exercise price of an option is typically set at the fair market value as of the time of grant (when the board of directors authorizes the grant of the option). This price is fixed—so even though the value of the stock may increase, the option holder gets to buy the shares at the earlier and lower fixed price. This is the key advantage of an option—the individual gets to wait and see how the company does before paying anything out-of-pocket. If the company does well and the stock increases in value, the holder can exercise the option by paying the exercise price knowing that the shares are then more valuable than the purchase price. If the company doesn't do well and the stock decreases in value, the individual can just choose not to exercise the option and therefore pay nothing. Compare this to restricted stock, where the individual must pay for the shares (or pay tax) up-front. Unlike a holder of restricted stock, however, the holder of an option is not a shareholder until the option is exercised. Until that time, therefore, the holder cannot vote the shares, and is not entitled to any dividends paid on the shares.