Free Float Vs Restricted Shares Vs Closely Held Shares: What Investors Need to Know 

Three key concepts in the share market often discussed for stock liquidity and volatility are Free Float, Restricted Shares, and Closely Held Shares. Each plays a distinct role in the dynamics of stock markets and understanding them can provide valuable insights into a company’s stock behavior and investment potential.  

Free Float 

Free float refers to the portion of a company’s shares that are available for trading by the general public. It excludes shares held by insiders, major stakeholders, and other parties with restrictions. 

The free float is crucial because it directly impacts a stock’s liquidity and volatility. A higher free float means more shares are available for trading, which generally leads to lower volatility. Conversely, a lower free float can result in higher volatility due to the limited number of shares available for trading.  

Stocks with a small free float have fewer shares in circulation, which means that any trading activity can have a larger impact on the stock’s price. A relatively small trade can move the price significantly because there are fewer shares available to absorb the buy or sell orders. 

In early 2021, GameStop (GME) became a prominent example of the impact of low free float. The stock had a relatively small free float compared to its trading volume, which contributed to extreme price swings during the short squeeze phenomenon. The stock surged from around $20 to nearly $500 within days before falling back, demonstrating how a low free float can amplify volatility. 

Restricted Shares 

Restricted shares are shares that are not freely tradable on the open market. They are often issued to company executives, employees, or insiders as part of compensation packages or investment incentives. These shares come with specific restrictions, such as a lock-up period or vesting schedule, during which they cannot be sold or transferred. 

Restricted shares are crucial for aligning the interests of company insiders with those of shareholders, but they can impact stock liquidity and market perception. Once the restrictions are lifted, there can be an increase in the number of shares available for trading, which might influence the stock’s price. 

Facebook (Meta Platforms Inc.) IPO: When Facebook went public in 2012, a significant portion of its shares were restricted. These shares, held by insiders and early investors, were subject to a lock-up period that prevented them from being sold immediately after the IPO. Once the lock-up period expired, a large volume of shares became available for trading, leading to increased market activity and a temporary impact on the stock price. 

Closely Held Shares 

Closely held shares are shares that a small group of individuals or entities own. These shares are typically unavailable for public trading and are held by company founders, family members, or a small group of investors. This type of ownership often results in a low free float. 

Closely held shares can result in a lack of liquidity in the stock market, making it difficult to buy or sell large quantities of shares without affecting the stock price. Companies with a high proportion of closely held shares may also have less market scrutiny and transparency. 

Berkshire Hathaway (BRK.A): Warren Buffett’s Berkshire Hathaway is known for having a high proportion of closely held shares. Buffett and a few other insiders own a significant portion of the company’s shares, resulting in a low free float. This concentrated ownership means that trading in Berkshire Hathaway’s stock is less frequent, and the stock may experience less volatility compared to companies with a more dispersed ownership structure. 

We will break down the different types of shares to illustrate how they impact a company’s stock dynamics: 
 

Company Overview 

• Authorized Number of Shares: 1,000,000 

• Outstanding Shares: 800,000 

Breakdown of Shares 

1. Restricted Shares- 
   The company issued 150,000 shares to its executives as part of an employee stock option plan. These shares are restricted and cannot be sold until certain conditions are met or a lock-up period expires. 

2. Closely Held Shares- 
   The company’s founders and major investors hold 200,000 shares. These shares are not widely traded and represent a significant portion of the company’s ownership. 

3. Free Float: 
   The number of shares available for public trading. 
    

Calculation: 

Outstanding Shares: 8,00,000 

Restricted Shares: 1,50,000 

Closely Held Shares: 2,00,000 

Implications 

1. Liquidity: With 450,000 shares available for public trading, the company’s stock has a moderate level of liquidity. Investors can trade shares more easily compared to a stock with a very low free float, but the liquidity may be less than stocks with higher free float. 

2. Volatility: The stock is likely to experience moderate volatility. The presence of 150,000 restricted shares and 200,000 closely held shares means that any significant trading activity among the free float could lead to noticeable price movements. 

3. Market Impact: The restricted shares could potentially impact the stock’s future liquidity when they become tradable. Additionally, the concentrated ownership of closely held shares may lead to less market transparency and lower trading volumes, further affecting price stability. 

Analyzing these factors helps investors make informed decisions about their investments and understand the implications of trading a particular stock. 

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