Why Should I Offer Stock Appreciation Rights?
Two of the most common benefit plans companies offer their employees are employee stock option plans (ESOP) and stock appreciation rights (SAR). While both have unique benefits, for the employer and its employees, there are differences and financial considerations that must be addressed before choosing the right benefit incentive plan for your company. Whichever plan you choose, each method motivates employees to increase shareholder wealth and offers compensation for their hard work and commitment. In this article, we will focus on SAR. Read our article on ESOP to compare options and follow up with business startup expert, attorney, Matthew Rossetti.
In the know – key terms
- Grant date is the date that the employer and employee agree to the terms and conditions of a stock option, or equity-based award. Once agreed upon the stock appreciation right is granted to the employee and the date is recorded as such. The grant date also determines the exercise price.
- Vesting date is the date an employee is eligible to exercise a specific number of options. Typically, starting on the date of vesting to the ending on the SAR’s expiration date, a vested SAR may be exercised, in whole or partially. Prior to this date, no payout will be granted. Note, exercising your rights may be dependent on how long an employee works for the company, employee performance, or based on the overall performance of the company.
- Expiration date refers to the last day an employee can exercise stock appreciation rights, and only if the market price exceeds the exercise price. However, if the SAR’s market price is below the exercise price, the shares are worth nothing and can never be exercised. Furthermore, If the terms and conditions of the bonus agreement are not met by this date, the employee will lose the SAR.
- Exercise price is the market price of the stock on the grant date, and the price an employee is able to purchase shares, once options are vested. There is also an exercise period, which is the time in between the vested rights and the expiration date, wherein the employee may exercise their appreciation rights.
Unpacking SARs
Offering a SAR is a great benefits plan for startups, especially if you are an S-Corp, LLC, partnership, or other business entity that is unable to award stock. A SAR allows a business to reward its employees without exhausting any cash reserves or giving up any equity and they can usually fund the rights through the organization’s payroll system.
Stock appreciation rights are essentially a bonus – usually paid out in cash, sometimes stock, or a combination of the two – to a company’s employees. These bonuses are issued with a grant date, an exercise price, a vesting date, and an expiration date. This type of benefit plan enables an employee to cash-in on appreciating stock prices, after a specified vesting period, between the grant date and the exercise date. However, this payout is only accomplished if the employer’s stock price rises.
Planning is key
The ability to create a customized benefits plan, structured for the betterment of a business and its employees, is what makes SARs a popular option amongst many businesses looking to incentivize their employees. Depending on how a company is set up, employers have a lot of flexibility when planning because there are few to no restrictions.
- Employers have the ability to offer their employees options to exercise their SAR when they choose to.
- Vesting schedules provide a performance-based retention tool, structured in a way that bonuses are only paid out if an employee lives up to the original terms and conditions agreed to on the grant date.
- Predetermined plans can be agreed upon as to what an employee will receive if he/she resigns or is terminated, if anything at all.
- Non-compete clauses can be implemented into the employer/employee agreement in order to ensure employee loyalty.
- Employers can further incentivize top performers by offering some of the net proceeds if the company is sold.
- Companies that already have an ESOP in place can offer SAR as an additional incentive for its employees.
Caveat
While stock appreciation rights do have their advantages, such as tax deductions for corporations, and no upfront cost to employees to exercise rights, there are a few things to understand in advance.
- An employer is required to withhold taxes, either by withholding cash or shares.
- Publicly traded companies may require shareholder approval when issuing stock appreciation rights.
- A company may need to follow retirement plan rules if it wishes to cover all employees and offer benefits after termination.
- Employees will not receive dividends or voting rights.
- Upon exercising rights, employees must report any income on the fair market value of the amount of the right received at vesting – even if it is a share and is not sold.
- If employees receive cash upon the sale of the company, it will be taxed as ordinary income tax
When planning, many decisions must be made carefully and strategically. Employers must consider vesting rules, liquidity concerns, eligibility, rights to interim distributions of earnings, tax implications and so much more. It is always advisable to discuss any plan to issue SARs with a knowledgeable attorney. Sentient Law is here to assist you.