Stock options were created to ensure that a company’s employees worked towards the same goal, which is to enhance performance and, as a result, profitability. Stock options enable employees to buy company shares at a discounted rate and sell it at a profit after a fixed amount of time that is decided by the employer. If the timing is right and the company is doing well, an employee can build wealth through ESOPs.
As cap tables get increasingly complex, companies have tried alternative ways to give employees the incentive received from ESOPs. One such concept is a stock appreciation rights (SARs) scheme.
In this article, we’ll see what SARs are, and should companies offer it to their employees?
What are Stock Appreciation Rights (SARs)?
Stock Appreciation Rights (SARs) are a type of employee compensation linked to the company’s stock price over a set time. Employees profit from SARs when the stock price of the company rises.
Employees do not have to pay the exercise fee when using SARs. Instead, they receive the sum of the increase in stock or cash. The significant benefit of SARs is that employees receive proceeds from stock prices without purchasing stock.
SARs, like other types of stock compensation, are transferrable and often subject to clawback clauses. Clawback provisions stipulate conditions under which the company can take back some or all of the employee’s income under the SARs plan.
Clawback provisions may, for example, allow the company to revoke SARs if an employee leaves the company for a competitor before a specific date. SARs are usually given according to a vesting schedule linked to the company’s performance goals.
Growing businesses widely use SARs for the following reasons:
- It provides incentives to employees without the company having to give up stock
- Business entities such as S-Corp, LLC, partnership opt for SARs because of their limited ability to award stock
- It adds a new type of incentive to existing plans like Employee Stock Option Plans (ESOP) and Employee Stock Purchase Plans (ESPP)
- It eliminates the need for employees to purchase stock options
Why Should You Offer SARs to Employees?
Employees can be rewarded for their contributions to the company’s growth without giving up shares. SARs are a popular choice among young businesses, such as startups trying to incentivize their employees. SARs allows employers to design a personalized benefits plan that is structured for the benefit of the company and its employees.
Employers have a lot of planning flexibility depending on how a company is set up because few limitations exist.
For instance, employers have payment options that vary based on their business structure, and they can usually fund the rights (if paid in shares) through their payroll system. In addition, payments can be made in cash, stock, or both.
Vesting schedules serve as a performance-based retention tool because incentives are only paid out if an employee adheres to the terms and conditions agreed to at the time of the grant.
It is possible to agree on predetermined plans for what an employee will receive if they resign or are dismissed, or if anything at all. Employee loyalty can be ensured by including non-compete terms in the employer-employee agreement. Employers can motivate top performers even more by offering a portion of the company’s net revenues if it is sold.
SARs have several benefits over other types of stock compensation. One of the advantages is receiving cash rewards without paying for workout options upfront.
Another benefit is the ability to tailor SARs to the recipients’ needs. For example, companies that offer SAR plans can pick and choose which employees will receive benefits, the liquidity of the SARs, the value of the bonuses, and the best vesting rule.
Employees also save money by not having to pay for a non-qualified stock option with their own money. Employees also benefit from the flexibility of SARs, which allows them to exercise their rights from the time it vests until it expires.
SARs are an employee motivation tool that gives additional incentives beyond regular pay linked to a company’s performance, motivating employees and lowering turnover.
In addition, compared to other types of stock compensation, SARs have more specific accounting standards. Due to eliminating the preferential taxation of the qualified stock options, SARs are also regarded as attractive compensation for employees.
The Bottom Line
SARs give employees the right to a percentage increase in the market value of their shares over a set time. Employers can provide SARs to employees in addition to stock options, which help them come up with the funds to pay the exercise price. Hence, SARs are considered in tandem with stock options.
trica is a unified technology platform for equity management and growth stage transactions. trica provides solutions to build and manage ESOPs, which enable companies to retain their star talent and keep teams motivated, save time by doing away with endless paperwork, customize their ESOP plan, and effortlessly run buybacks.
If you are looking for an easy-to-use tool to create your ESOP policy and manage ESOPs for your team, check out trica equity.