There are a number of ways to invest in the stock market, many of which involve making crucial choices of the companies you want to invest in for the long term. But what if, the company you work for offers you the option to invest in them, allowing you to have a more vested interest in the company’s future for years to come? This is made possible by various stock incentives offered by companies, the most common of which are restricted shares and stock options. But which one is better?
Here is all you need to know about the difference between stock options and restricted stock to help you decide.
What are Restricted Stock Units?
The first step towards understanding the difference between restricted shares and options is to review what each of them means, starting with the former.
Restricted stock units can essentially be understood as a stock-based compensation that is typically offered as an incentive to a company’s employees. This compensation is presented in the form of company shares and grants the employee a degree of equity ownership in the company. As someone with restricted shares in a company, you can enjoy not just ownership but also various benefits such as dividends as well as the voting rights, privileges, and responsibilities associated with being a shareowner.
However, the reason why these stock units are termed “restricted” is that they are accompanied by certain provisions that an employee must keep in mind. These conditions can range from the employee spending a specific number of years with the company to the company achieving specific milestones in the future. In any case, restricted shares are vested which means the employee must meet these conditions to receive actual shares.
What are Stock Options? Next on the restricted stock units vs stock options discussion, let us review what stock options mean.
By their basic definition, stock options are contracts by which the option holder has the right, but not the obligation, to buy or sell a specified number of shares of a stock within a predetermined period. Stock options are commonly traded in the share market and like restricted stock units, are often also used as a means of employee compensation or incentive.
However, at the time that they are issued, stock options do not grant ownership in the company to the employee. It is simply an agreement that the employee will have the option to purchase company shares in the future, at the price determined at the time of issuance. Therefore, the employee is compensated by the profits he or she can make based on the difference between their stock option price and the current market price of the stock in the future.
Difference Between Stock Options and Restricted Stock
Now that you are familiar with both of these relevant concepts, let us take a closer look at the points of difference between stock options and restricted stock units.
The first thing of note here is that both restricted shares and stock options are granted by companies as a means of employee compensation or forms of incentive. However, the difference between restricted shares vs options lies in what these incentives mean in the long term.
In the case of restricted stock units, the employee can enjoy dividends as well as voting rights and other privileges of a shareowner in the company. However, in the case of stock options, the employee receives none of these as they are not granted ownership in the company but simply the right to exercise the stock option. In the event that the employee does exercise this option, they too can receive the aforementioned benefits.
The other point of difference between restricted stock units vs stock options is that of risk tolerance. Stock options might hold more immediate value but unlike restricted stocks, they can expire out of the money. On the other hand, while restricted stocks cannot be sold immediately, they do carry more long-term value.
It is important to note that since restricted stock units carry more long-term value, they are more often awarded by larger, more well-established companies. Meanwhile, stock options are granted by smaller businesses and startups. At the end of the day, the restricted stock units vs stock options debate largely leans in the favour of whatever holds more value for you and the specific incentives offered by your company.