Forfeited shares are a critical concept for investors and employees involved in stock purchase programs. This article explores what forfeited shares are, how they work, and their implications for both shareholders and companies.
What Is a Forfeited Share?
A forfeited share is essentially a share in a publicly-traded company that the owner loses due to their failure to meet specific requirements set by the company. Common scenarios leading to forfeiture include:
- Failure to Pay: If a shareholder neglects to pay amounts owed on shares, such as call money, the company can seize those shares.
- Selling or Transferring Restrictions: If there are restrictions on selling or transferring shares within a certain timeframe and the shareholder violates them, the shares may also be forfeited.
Once forfeited, the shareholder no longer owes any remaining balance on the shares and forfeits any potential capital gains. The shares revert back to the issuing company, which may then decide what to do with them.
Key Takeaways:
- Forfeited shares are shares lost by an owner due to failing to comply with purchase agreements.
- The forfeiting shareholder relinquishes any financial obligation and potential gain on those shares.
- Shares revert to the issuing company, which has the discretion to reissue them under varying terms.
How Forfeited Shares Work
To illustrate how forfeited shares operate, let’s consider an example with a hypothetical investor named David. David agrees to purchase 5,000 shares at a 25% initial payment requirement, followed by three annual installments of 25%. If David fails to make one of the payments, the company is entitled to seize all 5,000 shares, resulting in David losing the money he originally paid.
It's worth noting that companies are not legally obliged to forfeit shares automatically due to non-payment; they can choose to offer grace periods, allowing shareholders more time to settle their dues.
Employee Share Forfeiture
Many companies promote employee engagement and retention through stock purchase plans, where employees can buy discounted shares. However, participation often comes with restrictions. For instance, workers might not be able to sell or transfer their shares for a specific period.
Additionally, if an employee leaves the company before fulfilling a mandatory waiting period, they may be required to forfeit their shares, which means they could completely lose their investment. In contrast, employees who remain with the company for an agreed-upon period become fully vested and can cash in their shares.
An example of this is the restricted stock unit (RSU) plan. Companies may offer employees a certain number of RSUs as a reward that vest incrementally over multiple years. If an employee quits before the vesting period is complete, they might lose the unvested units, significantly affecting their overall compensation package.
Example of Forfeited Shares
Imagine a company awards an employee 80 restricted stock units as an annual bonus, where the vesting schedule releases 20 units per year for five years. If the employee decides to leave after the second year, only the first 20 units vested will be retained, while the remaining 60 units are forfeited.
Reissue of Forfeited Shares
Once shares are forfeited, they become the property of the issuing company, which has several options for what to do next. Companies can reissue forfeited shares either at par value, at a premium, or at a discount. The specifics of this decision depend on the company's board of directors.
Typically, shares are reissued at a discount to encourage new investors or to compensate for the lost investment by shareholders. If shares were initially offered at par, the maximum discount on reissued shares is usually limited to the amount forfeited. It's important to note that companies cannot return forfeited shares back to the original shareholder who defaulted but can sell them to other interested parties.
Conclusion
Forfeited shares represent both a risk and opportunity within the realm of corporate finance and employee compensation. For employees, understanding the terms and conditions surrounding share purchase plans is essential to mitigating potential losses. For companies, effective management of forfeited shares can lead to strategic re-issuance and reinforce employee loyalty while minimizing financial loss.
In summary, both shareholders and companies need to navigate the complex landscape of forfeited shares judiciously, taking into account the financial implications and potential benefits that may arise.