Sometimes, companies use stock options or restricted stock awards as a way to attract talent. These perks are offered as part of an overall compensation package.
Restricted stock awards
A restricted stock award is a grant of company stock given to a recipient, typically an employee. Generally, the recipient does not have to pay for the shares, but rather must fulfill certain requirements, such as remaining an employee for a certain length of time, until the restrictions associated with the stock award are lifted.
The time frame during which the recipient's rights are restricted is known as a vesting period. Once the vesting requirements are met, and the vesting period ends, the recipient of the stock award is granted full ownership of the shares. At that point, the shares can be treated just like ordinary shares of stock.
Stock options work a bit differently. When a company grants stock options to an employee, it's giving that employee the right, or option, to purchase a certain amount of stock at a fixed price at some point in the future. Restricted stock awards typically do not require the recipient to pay for the shares in question; but with stock options, the option holder must pay a preset price for the stock when the time comes to exercise that option.
Employees who hold stock options have the potential to profit if the stock's market value increases from the time the options were issued. Imagine you're given the option to purchase 10 shares of your company's stock at $100 per share after a three-year vesting period. If, at that point, the shares are worth $300 apiece, you can buy your 10 shares for just $1,000 even though the going price for that many shares is $3,000.
Once you purchase your shares, you're free to hold them or sell them at a profit. Similarly, if the shares are worth just $50 at the end of your vesting period, you don't have to buy them at a loss. You can just let your stock options expire.
Restricted stock lapse
As the name states, restricted stock awards come with certain limitations. Once you're fully vested in those shares and the restrictions lapse, you're free to treat your shares as ordinary shares. This means you can sell or transfer them as you see fit.
Lapsed stock options
When you're given stock options, you must exercise your options during a certain time frame. If you fail to exercise your option to purchase the stock during that time, your options will lapse. At this point, those shares of stock will no longer be reserved for you to buy at a predetermined price.
Whether you're given a restricted stock award or stock options, it's important that you understand the nuances and requirements involved. You may need to take certain action to capitalize on your stock options or award, so be mindful of your vesting schedule and its associated rules.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center, in general, or this page, in particular. Your input will help us help the world invest, better! Email us at firstname.lastname@example.org. Thanks -- and Fool on!