What Is a Restricted Stock Agreement?
As commonly understood, an agreement that places certain restrictions on the stockholder’s rights with respect to the shares being issued is referred to as an RSA. The need for a restricted stock agreement emerges during issuing restricted shares to new owners of a start-up. Most of the new companies do not have enough cash and hence enter into financial arrangements through stocks issued over a certain period of time.
These transfer restrictions come into play through two types of agreements: one among the founders of a start-up, and the other on the insistence of the investors. While the former ensures contribution by each founder, the latter sets to appease the investors. The legal purpose of these different aspects would be understood in the coming sections.
Who Are the Parties to Such an Agreement?
Founders of a company enter into an RSA to restrict selling, transferring shares, etc., and give a series of rights in favor of the Company to buy back shares, exercise a right of first refusal, and others. Generally, Investors want to see the founders’ shares being taken in a manner that preserves the company’s ability to take firm action in the future.
What Is the Purpose of a Restricted Stock Agreement?
- The main objective of a Restricted Stock Agreement is to limit trade engagements (selling, transferring) with reference to a company’s stocks. Companies seek to create boundaries in order to confine the number and kinds of commercial exchanges which can be made through its stocks.
- The secondary aim is to preserve the reputation of the company in the commercial arena. By displaying a certain degree of control and collaboration, an RSA fulfills the function of attracting and appeasing investors.
What Are the Contents of a Restricted Stock Agreement?
- Vesting and Conversion: This involves the restricted stock grant and the time taken for such a grant.
- Dividend Equivalent Payments: This clause deals with cash payments in case the Restricted Stock Units (RSUs) are not converted into shares.
- Restricted stock units tax: If any tax is levied on the restricted securities, the same may be included.
- They have restricted Stock vs. Stock Options: The difference between these two restricted stock and stock options should also be contained in the agreement.
- Change in Control: In the event of a change in control, RSUs are generally vested and converted into shares, effective on the date of such change in control.
How to Draft a Restricted Stock Agreement?
What points should be considered while drafting the same?
- The first essential for entering into an RSA is having consensus amongst the founder members with respect to their limited responsibilities. In case there is a conflict in the future with regards to lesser benefits, it would surely reflect unprofessionally on the part of the company’s management.
- There should be a complete understanding of the applicable laws of the land. In most cases, founders engage a legal consultant to broker an agreement between them. It is significant to be familiar with the rules and provisions governing the founding and investment companies as well.
- To drafting a restricted stock agreement, there must be clarity as to the limits which are to be placed on stock dealings. Most conflicts between founders in such cases arise due to lack of lucidity with respect to the terms of use, and authority overstocks. Such details must be covered in the agreement, as simplistically as possible.
- The purpose must not only be to allure investors; it must also be to affirm your company’s role as a fantastic professional body that hires and maintains only responsible and organized individuals.
What Are the Benefits and Drawbacks of a Restricted Stock Agreement?
Benefits:
- RSAs allow the benefit of allowing founders to not rely merely on cash, but also judicially use the stocks of the company for payments.
- They further bring about a sense of responsibility towards the usage of stocks; by limiting the kind of ways in which stocks might be employed, a company ensures proper and skilled administration of its resources.
Drawbacks:
- A restricted stock agreement might be subject to numerous changes over time. A vesting schedule cannot remain constant in this evolving business world.
- Second, the departure of founders might not only bring about mismanagement in calculations, but it may also hinge the dealings of the company, which hinges on a set composition of the management.
What Happens in Case of Violation?
Generally, any violation of a Restricted Stock Agreement brings about forfeiture of shares by the company. Further, the entire dealing wherein the terms of the RSA are violated, are deemed null and void in law. Hence, it is much to the company’s discretion at the time of entering into an RSA, to clarify the repercussions of going against the arrangement.
With an exponential increase in the number of start-ups and entrepreneurs, there is always a necessity to enter into financial agreements. These cannot totally be based on cash. Stocks as equity have emerged as an important, and quintessential part of the economy. New companies generally. It is of utmost necessity, today, that firms and entrepreneurs familiarize themselves with the relevant provisions of law applicable in case of entering into an RSA, and what are the ideal ways in which the same might be formed.
Sample Restricted Stock Agreement
A sample of the Restricted stock agreement can be downloaded from below.
