Stock Appreciation Right (SAR)
A form of equity compensation tied to the company's stock price to reward and retain employees.
What Is A Stock Appreciation Right (SAR)?
A stock appreciation right (SAR) is a form of equity compensation tied to the company's stock price to reward and retain employees. It makes employees take advantage of the increased value of the stock without the requirement of buying the corresponding stock.
SAR is similar to the employee stock option because it is advantageous for employees when the company's stock price increases. The only difference is that employees are exempt from paying the exercise price in SAR but receive growth in stock value or cash.
- Grant: Similar to stock options, SARs are granted at a defined price used to determine the appreciated value when acquired.
- Vesting: Similar to stock options, SARs typically have a vesting term, which means the waiting time before receiving ownership of the award, has an expiration date. Once a SAR vest (becomes available to exercise), employees may exercise it at any point before its expiration.
- Exercising: Unlike stock options which require employees to pay an exercise price, employees do not need to pay anything up ahead to get the awards.
When you want to get your stock appreciation rights, you usually have to let your company know by following the steps in your stock plan or grant agreement. You can get the money from a stock increase in cash or the same number of new company shares.
In other words, think of this right as an appreciation method in the company, which means that the holder gets compensation in the event of an increase in the stock value in the market during a specific period.
SAR grants the holder (employee) the option to receive compensation equal to the difference between what the stock was worth when you were granted it and what it is worth when the employee gets it.
Key Takeaways
- Stock appreciation right is a type of employee compensation that relies on the stock price.
- SARs have a vesting period, meaning the waiting period before gaining ownership of the award has an expiration date. Once SAR vests, employees may exercise it any time before its expiration.
- SAR is preferable for companies since employers don’t have to dilute their share price by issuing additional shares.
- SAR benefits employees and employers alike by encouraging longevity and giving increased benefits to workers based on productivity.
Understanding Stock Appreciation Rights
A Stock Appreciation Right is the right to get paid more if the price of the company's stock goes up during a defined period. Employers give this kind of compensation in cash, but the company could provide the employees with a bonus in the form of shares.
It is given out at a set price, which is used to figure out how much they are worth when you get them. When a SAR vest (becomes accessible to be exercised), employees can use it whenever they want up until it expires, and they aren’t required to pay money to exercise SAR.
It gives employees a right to get the difference in the value of a company’s stock share when it goes up in value, which means that employees do not directly own equity in their company.
The SAR program sets the vesting timeline for each employee, after which it may be exercised, which means that employees don’t have the flexibility to choose when to use their rights.
Generally, the agreement links SARs to the company's performance goals, so employers issue this reward to benefit employees regarding the stock value or cash growth.
Stock Appreciation Right (SAR) Example
For example, Tia granted stock appreciation right on 20 shares of TYL’s stock valued at $15 per share. After a defined period, the share price increases from $15 to $20. This means that Tia would receive $5 per share due to the increasing share price in the market.
By determining the difference of $5, Tia will receive a total of $100 ($5 * 20 shares = $100).
Tia will get $100 in the reward paid in cash; however, she could get five shares ($100 / $20 = 5 shares) if the compensation payout is in shares.
It can be transferred and come with a clawback policy. The clawback policy outlines the circumstances in which the business may reclaim all or a portion of employees' compensation under the plan.
In other words, a company may decide to withdraw SAR once they feel that it works against its performance goals. They could cancel it anytime if they discover some employees break the company guidelines, such as working for competitors.
Tax Treatment of SARs
Stock appreciations are subject to the same taxation rules as non-qualified stock options—neither the date of grant nor vesting results in any taxable income.
The administrative responsibility of withholding tax collection and submission to the Internal Revenue Service falls on employers.
In other words, Similar to non-qualified stock options (NSOs), employees are not required to declare anything for tax purposes until they exercise. The tax check in each stage of the SAR life cycle is as follows:
1. Grant
When granted, there are no federal income tax consequences like stock options.
2. Vesting
There are no federal income tax consequences like stock options at the time of vesting.
3. Exercising
The increased value is subject to payroll tax and is taxed as earned income. The appreciation is the difference between the market price at the time of grant and the market price at the time of award, multiplied by the quantity of stock appreciation received.
For example, Consider Lina is granted 200 stock appreciation. The stock's price at the time of the grant is $50, and the price of the stock after vesting is $70. Lina wants to get the award before it expires.
- Lina will receive $20 for each stock appreciation right ($70 - $50 = $20), and she will receive a total of $4000 in cash ($20 * 200 = $4000).
- If the reward pays out in shares, Lina will receive 57 shares ($4000 / $70). Hence, the taxable income will be $4000 [($70 - $50) * 200].
4. Sale
You might have to pay a capital gains tax if you get stock shares after vesting and selling them. Sticking with Lina's example, if Lina desires to sell her shares for 75$, share price appreciation after selling will be subjected to tax as short/long-term capital gains.
Remember that selling shares after exercising them requires you to hold your Sar for a minimum of 12 months so that the money you get from selling them can be taxed as a long-term capital gain.
SAR Vs. Stock Options
Stock appreciation and stock options are types of employee compensation that can be used to attract and retain talented employees. However, there are critical differences between these types of stock that companies can offer, but which is better depends on the company’s goals.
The similarities between SARs and stock options are as follows:
- Both are granted at a defined price to determine the appreciated value when you acquire them.
- Both are a type of employee compensation that relies on the increase in the stock price.
- Both are subjected to a vesting period and expiration date.
- Both can pay out in the form of shares. However, remember that stock appreciation right more often pays in cash than shares.
- Both don’t give employees voting rights since they don’t consider actual shares.
The differences between stock appreciation and stock options are as follows:
- Exercising
- Stock appreciation: Employees can exercise or receive an award after it has vested without paying for it before it expires.
- Stock options: Employees must pay an exercise price to get the award after it has vested before it expires.
- Award form
- Stock appreciation: Employees can be paid out in the form of cash and shares once they are exercised.
- Stock options: Employees are paid out in the form of stock shares once they are exercised.
- Taxation
- Stock appreciation: When stock appreciation rights are exercised, they are classified as taxable compensation. Capital gains tax may be applied if shares are received and later sold. Your tax situation differs If you receive non-qualified or incentive stock options.
- Stock options: The tax implications differ depending on whether you get non-qualified or incentive stock options.
- Types
- Stock appreciation: may be "connected" to or "untied" from the stock's performance. Tied one only pays out if the stock price exceeds the grant price, whereas untied one pays out regardless of the stock price.
- Stock options: Incentive stock options (ISOs) and non-qualified stock options are the two basic categories of employee stock options (NQSOs).
Only employees can use ISOs, and they receive special tax treatment. On the other hand, NQSOs are available to anybody and are taxed at the same rates as ordinary income.
As mentioned above, these metrics are similar but different since they meet different needs. The question could be which is best for your company and your goals.
This is a difficult question because it relies on the business's requirements and the personnel's preferences. Employee stock options may be more desirable to individuals looking for a long-term investment.
In contrast, the right of stock appreciation may be more desirable to those seeking an immediate payoff.
Stock appreciation right is the right option for you if you have the following:
- A limitation in paying out a reward in the form of shares, so paying out cash works better for you.
- Desires to keep your employees away from the requirement to pay to get the reward.
- A company’s shareholders plan to reduce the dilution issues with the stock award.
Advantages of SARs
There are numerous benefits to exercising this program for employers and employers simultaneously. The primary advantages of the stock appreciation right are attracting talented employees, flexibility, dilution of stock, and favorable accounting treatments.
Benefits for employers can be summarized in the following points:
- Flexibility: The ability to adjust the right of stock appreciation to the company's needs. Employers who use stock appreciation plans can choose the employees who will receive the benefits, how to pay out the reward (cash or shares), the vesting schedule, and the expiration date.
- Less dilution of stock: Stock appreciation allows employers to give employees equity-linked pay without diluting their share process by issuing additional shares.
- Motivate, retain, and attract talented people: Employers can set the best vesting schedule that meets talented people’s requirements. Hence, they attract, retain and motivate qualified employees and reduce turnover rates to improve company performance.
- Favorable accounting rules: The program of stock appreciation receives fixed accounting treatments and fewer accounting rules.
However, The best thing about this compensation for employees is that they don't have to use their own money to buy stock or stock options in the first place.
Employees will benefit from this compensation when the company's stock price goes up, and they get the amount of the price increase in cash or more shares of the company. In other words, employees get a side income beyond their regular income.
However, the company could cancel this program if something works against its goals. So, employees shouldn’t consider stock appreciation a fixed income and cannot sue the company if compensation is canceled.
Suppose your company keeps going with stock appreciation plans, but you have to leave the company. In this situation, you may/ may not receive your awards; it all depends on the company policies and how they structure the stock appreciation.
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