Stock Appreciation Rights for Private Companies

Several companies take the course to employee ownership through employee ownership schemes such as stock options, an ESOP, or a systematic stock purchase scheme with tax benefits. However, other companies, due to expense, compliance needs, or organizational issues, may not find these suitable. Still, others may keep one or two of such plans and prefer to complement them for some employees with a separate plan, such as stock appreciation rights or phantom stock, that offers extra equity incentives without offering the stock itself and may appear promising.

An Overview of Stock Appreciation Rights (SAR)

An SAR is a future or delayed incentive compensation to workers and is spent when the stock of the company appreciates in market value above the option exercise price. SAR gives an employee who owns shares in a company the right to a cash deposit proportionate to the growth of stock transacted on a public securities market. SAR varies from a stock option by the fact that an employee gets similar proceeds without the need for cash expenditure connected with buying the option directly

A company’s SAR program offers the flexibility to frame the compensation arrangement in a manner that is convenient for its beneficiaries. The “SAR program” lays out the nitty-gritty and conditions for allowing and practising SARs, comprising of a vesting timeframe for the employee to earn their right to receive the stock price appreciation benefits, exercise price, and options by way of cash or stock settlement. This strategy links SARs with the performance goals envisioned by the company.

Employers can grant SARs to assist employees, side by side, with stock options to raise funds to pay the market price of the stock on the date the SARs are issued. SARs perform as a kind of incentive compensation. They are usually approved under the stock options strategy because, as tandem SARs, they are a vital tool to assist employees in covering the cost of stock options and income taxes on any capital gains that need to be mentioned in your tax returns.

If you retire, you can possess your own outstanding SARs. Discuss it with your employer for more understanding. After you exit from the organization, there are specific rules as well. It is preferable to investigate this matter with your employer. Lastly, the SARs you own will be transferred to your nominated beneficiary after death.

Let us understand SARs through an example:

Suppose that XYZ Limited issued stock appreciation rights on March 1, 2012, when the stock price was Rs. 15 per share, and the vesting time for the employee to exercise the right is on March 1, 2022.

Arun was granted SARs for 100 shares of XYZ Limited. Presuming that the share price of the company’s stock on the vesting date is Rs. 75, the value in cash of Arun’s SAR is Rs. 6,000 [(Rs.75 – Rs. 15) x 100]. Arun can elect to get the SARs transacted in cash for Rs. 6,000 or in XYZ Limited’s shares of stock equal to 80 shares (Rs. 6,000/Rs. 75).

How SARs Operate?

Your employer awards a grant explaining the particulars of your SARs. The grant consists of a grant or exercise price, grant date, vesting period, and expiration date.

• Grant date is when your company executive confers you the grant or SAR, and the vesting schedule starts from this date. This specific date also sets the market price of the stock and is the date the employee is authorized to benefit as the stock price rises in the future.
• Grant or exercise price is essentially the market price of stock at the time the SAR is issued and is used to decide the amount you earn after you exercise your stock appreciation rights. It is the baseline to measure the performance of the stock. The total sum of money that an employee receives upon exercising their SARs depends on the surplus value over the grant price.
• The vesting date is the specific date when you are in ownership of the shares and can claim the stock price value appreciation depending on their granted rights. Employees can realize the valuable gain after the completion of the vesting period.
• Exercise period is the timeframe within which you claim the SARs value. It starts after the culmination of the vesting period and finishes on the expiration date. It refers to the time you have to claim the sum of money you are entitled to get as an employee based on the rise in the stock price of the company over a given duration.
• Expiration date is the concluding date of your right to exercise the SARs.

Important Takeaways

• Employees owning company shares and acquiring stock appreciation rights (SARs) qualify for cash deposits or payments equivalent to the rise in share prices.
• SAR plans can be customized, and companies adapt them in a way to design compensation policies that are beneficial to their employees. Besides, it also permits employers to utilize the SAR programs as an instrument for incentivizing and keeping on their payroll every single worker in the team
• SARs are generally allotted to employees on top of their usual earnings or as a substitute for conventional stock options. A prevalent practice is for companies to grant SARS jointly with stock options. In the event of a mix of both, employees can receive funds to meet the exercise cost or strike price of stock options utilizing the profits reaped from SARs payments.
• Besides, SARs are usually transferable but may contain clawback clauses that facilitate the company’s recovery of rights in certain circumstances, such as the employee moving to a competing company. This arrangement of SAR synchronizes employees’ priorities with a company’s economic performance or output of a company by recognizing them for a rise in stock value.

One of the substantial advantages that SARs can produce is their minimal use of money to apply for cash. In this kind of equity compensation, an employee acquires the proceeds without being obliged to make payments for the share price. Another advantage that ensues is flexibility, wherein companies can structure SARs to meet the demands of separate employees. Such flexibility calls for individual choices. Enterprises offering SARs select the employees suitable to receive them, the incentive amount, liquidity of SARs, and the vesting schedule or timeframe to adopt when the SARs are exercisable.

Employees opt for SARs because of their traditional accounting principles. They provide consistent accounting treatment in place of variable or fluctuating accounting treatment, which is highly suitable for employees. SARs cause a lesser decrease in the value of shares and the issuance of fewer shares. Besides, they help motivate and retain the workforce.

SARS and Taxation

There is no taxation on SARs unless you use the value in money or stock. In that case, it is taxed as usual or current income. If you obtain stock after the exercise period, you will use it to acquire the cash equivalent after the appreciation of the stock price, and you will need to pay tax on any extra profits during the time of stock selling.

An employer generally allocates a specified number of shares and withholds the rest to reduce the tax obligation. When holders go public and sell their shares, the revenue earned upon exercise turns into the cost basis. Your stock selling can either earn capital gain or financial loss based on the appreciation or decline of the stock value. When the sale price of your exercised stock surpasses the cost basis, you will be liable to capital gains tax.

Stock Appreciation Rights As Opposed To Employee Stock Options

Feature	Stock Appreciation Rights (SARs)	Employee Stock Options (ESOs)
Ownership	Gain from share price without necessitating their purchase	Must apply the choice to purchase company shares at a fixed rate to benefit from a rise in their value
Incentive	Employees obtain shares or cash parallel to the increase in share value	Employees buy shares at a given price and later sell them to secure a profit
Taxation	Earnings from SARS are levied as regular income at the period they are implemented	Taxation differs: Non-qualified stock options (NSOs) are charged as ordinary income when practised, whereas incentive stock options are charged against the sale of shares
Taxation Period	Tax due upon exercising of SARs	Non-qualified stock options are charged when implemented; incentive stock options undergo taxation upon the sale of shares
Capital Gains Tax	It is relevant only when the stock conferred as a portion of the SAR is sold	Applicable solely when the shares received through using the options are sold
Relevance	Appropriate for employees unsure about stock possession of the company for the long term but expecting to benefit from its higher value.	Ideal for employees certain about the company’s expansion and want long-term stock ownership
Financial Risk	No initial investment is needed, which restricts the benefits but also curtails financial risk.	An initial investment is a requisite for buying shares, resulting in greater likely profits but also higher financial risk.

Wrapping Up

Stock Appreciation Rights (SARs) are a traditional way of incentivizing and rewarding employees. In India, they’re predominantly seen as a sound method of providing equity-based rewards and as a workable option to ESOPs. Startups can find SARs a helpful option for presenting a flexible structure that assists both employers and workers regarding incentivization. SARs can be beneficial in framing an incentive strategy that synchronizes with the vision and objectives of startups in their business journey.

Related Sevices

• Private Limited Company Registration
• Share Transfer Online