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Restricted Stock

Definition - What does Restricted Stock mean?

Restricted stock is typically issued to a seller as part of the consideration for a transaction. It is restricted to ensure the seller meets certain post-transaction requirements imposed by the buyer. Restricted stock can be cancelled or purchased back by the buyer at the original cost if the contingent requirements are not met.

Post-transaction requirements may include:
  • Meeting future profitability targets in which case the restricted stock has been issued as a form of earnout prepayment;
  • Ensuring the management team from the seller stays on for a specified time period. If any of the key managers leave, the stock they received may be cancelled; and
  • Ensuring that the management team from the seller abides by any non-competition agreements in place. The restricted stock serves as a form of soft enforcer of the non-compete.

Divestopedia explains Restricted Stock

Some buyers use restricted stock regularly as a way to ensure post-transaction conditions are met. A seller must ensure that these conditions are fair, and do not compromise their ability to retain the stock. The issuance of restricted stock may be viewed as a negative for the seller - it basically states that the buyer does not have confidence that some of the deal terms will be met including how long the management will stick around, or whether or not they will compete post transaction directly or indirectly through other companies. Therefore, restricted stock complicates a transaction structure, and it may be best to avoid this form of consideration altogether even if it means taking a lower purchase price.

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