Equity compensation plans offer key employees an extra incentive to perform well. However, the cost of purchasing the shares underlying such equity compensation, as is required in most stock option plans, can put such compensation out-of-reach of many employees. Stock appreciation rights plans, however, can offer a lower-cost way to link compensation to increased company value. If you’re considering a stock appreciation rights plan, speaking with a securities and employment benefits lawyer in the Priori network can help.
About Stock Appreciation Rights Plans
Stock appreciation rights (SARs) plans are one of the simplest forms of equity compensation for employees. Under stock appreciation rights plans, rather than employees exercising an option to purchase stock of the company, they award the employee with the profit reaped from any increase in the price of the shares between the grant and exercise dates after a certain vesting period. Usually, SARs are paid-out in cash, but sometimes stock is awarded instead.
How SARs Are Exercised
Generally, stock appreciation rights plans are set up in the same way as any other form of stock compensation plan. They have a vesting structure, and they can be exercised at any time when the employee wishes after the vest date. To exercise them, however, no stock must be purchased. Instead, the employee can simply claim the dollar amount of appreciation in the share price between the grant and exercise dates on the day of their choosing.
SARs paid out in shares are slightly more complicated to exercise than cash options, but the principle is the same. The employee is issued stocks valued in an amount that equals the appreciation on the exercise date amount minus withholding taxes. Unlike most stock options, however, the employee does not have to buy the shares first. They are simply awarded directly. After the stock has been transferred, the employee can either sell the shares for the same cash profit or hold onto the stock.
Advantages and Disadvantages of SARs
The main advantages of SARs for employees is that no money is required to exercise them up front. Instead, the employee receives SARs as a more direct bonus. From an employer’s perspective, SARs have the main benefit of being relatively simple, flexible instruments. In addition, issuance of company shares is reduced relative to other types of stock plans, avoiding problems of share dilution.
There are some disadvantages of stock appreciation rights plans, however. Employees do not receive dividends, nor do they receive voting rights, thus decreasing their influence. Employers, on the other hand, must carefully consider many factors before issuing SARs. Since they are such flexible instruments, vesting rules, liquidity concerns, eligibility, rights to interim distributions of earnings, and other decisions must be made carefully or stock appreciation rights plans can fall afoul of securities regulations. It can therefore be helpful to discuss any plan to issue SARs with a qualified securities lawyer.
Depending on your situation, the cost of hiring a lawyer to implement a SAR can vary. Hourly rates for Priori securities and employment lawyers lawyers start around $225 per hour and range up to $450 per hour. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and receive a free price quote from one of our lawyers.
What are tandem SARs?
When SARs are granted in conjunction with incentive stock options, they are called tandem SARs. Usually, such stock appreciation rights plans are intended to help finance the purchase of the stock options or pay taxes if any are due upon their exercise.
What’s the difference between SARs and phantom stock?
Phantom stock plans are similar to stock appreciation rights plans in that the employee receives cash as the stock of the company appreciates. Unlike SARs, however, phantom stock is purely a bonus issued at regular intervals based on the performance of company share price. SARs are an option that the employee has the right to exercise at will within the grant period.
What’s the difference between stock appreciation rights plans and stock options?
Both are forms of equity compensation plans, but they are exercised differently. Stock appreciation rights plans don’t require the employee to pay out anything to receive the benefit of the share appreciation. Stock options, on the other hand, are simply a right to purchase company stock at the price of shares on the grant date.