An Overview of Stock Appreciation Rights

By Drew Stevens - December 4, 2018 - Securities

Stock appreciation rights (SARs) can be a great option for startups and businesses that want to reward and retain key employees. Although stock appreciation rights can be confusing, a good business law attorney in Columbus, Ohio with securities expertise can make rolling out a SARs plan much easier. In the scheme of employee equity incentive plans, SARs plans are similar to phantom stock in that SARs do not actually require actual shares or units to be issued to an employee, but SARs plans do have some differences as compared to phantom stock.

What are Stock Appreciation Rights (SARs)

Stock appreciation rights are basically exactly what they sound like – a business is granting an employee the right to receive the monetary difference in appreciation of the company’s stock price. Once an employee is able to exercise the SARs, the employee will be paid an amount equal to the difference in the share price (between the grant date and the exercise date) times the number of shares specified in the grant.

Example time. In May 2018, your software startup grants Diane Diligent a SARs plan that provides for 100 shares. At the time of the grant, the shares are worth $50 each. Fast forward to May 2021, where the company has grown, and the shares are now worth $100 each. Diane Diligent has met all applicable vesting requirements, and she wants to exercise her SARs plan. Your company will write Diane a check for $5,000 (100 shares x ($100 – $50 = $50)).

Positive Components of SARs

Like phantom stock, SARs can be highly customizable and can remove dilution and more traditional equity grant concerns. Companies can incorporate various vesting features, such as double trigger vesting – to exercise SARs, the employee must both remain employed for a certain time period and hit specified performance milestones.

Issuing SARs isn’t the same as actually issuing units or shares. Like phantom stock, founders don’t have to worry about cap tables, restructuring operating agreements or corporate documents, or the dilution effects of issuing additional shares or units. Current stockholders also don’t have to worry about voting percentages required for majority or super majority votes, as SARs aren’t the same as holding common or preferred stock.

For the employee, the taxation treatment of SARs can also be a plus. SARs are only taxed when the employee exercises the SARs, meaning employees aren’t hit with up-front taxes when the SARs are originally granted.

SARs Concerns, Considerations, and Issues

As with phantom stock, care has to be taken with structuring SARs plans, especially in light of ERISA (the Employee Retirement Income and Security Act) and internal revenue code section 409A. Companies and startups can craft their SARs plans to be exempt from 409A, if the following requirements are met:

1. The total amount paid to the employee at the time of exercise cannot exceed the difference between the grant price of the stock and the fair market value of the stock at the time of exercise, and the payment is made on the exercise date.

2. The grant price in the SARs grant must be equal to or greater than the fair market value of the stock on the grant date.

3. The grant must specify the number of shares on the grant date.

4. The employee cannot defer the payment income beyond the date of the SARs exercise date.

If you’re contemplating implementing a SARs plan with your company, a Columbus business law lawyer at our firm can provide structuring advice and assist with drafting the stock appreciation rights agreements. Contact our firm and let us know how we can assist you.