Stock Appreciation Right (SAR)
Introduction to Stock Appreciation Rights (SARs)
What Are Stock Appreciation Rights (SARs)?
SARs are a type of compensation plan that provides employees the right to receive payment based on the increase in a company's stock price above the price specified in the SAR grant. They're a contractual right, not an actual equity holding, and as such, they do not require the employee to purchase shares. Rather, employees are typically paid in cash based on the increase in the stock price, and in most cases, the employee has control over if/when they exercise the SAR and receive compensation.
How SARs Work/Key Components
Number of Shares
The SAR agreement specifies a number of shares associated with the grant.
Exercise Price
The exercise price is the fixed price per share of stock, which is used as a reference point to determine if/how much value your SARs have:
When the current stock price is higher than the exercise price of your SAR, it is said to be "in the money." This means it has value, and you would receive a payout if you exercised the SAR at that time.
When the current stock price is lower than the exercise price, the SAR is said to be "underwater." It would currently have no exercisable value, but they still have "option value" -- as the stock price could increase in the future (to a point at which the SAR does have exercisable value).
Vesting Start Date
The vesting start date is exactly as it sounds; the date the vesting begins.
For new-hire grants, vesting typically starts on the employee's start date.
For existing employees (getting new/additional grants), the vesting start date can vary but is usually somewhat close to the grant date.
Vesting Schedule
The vesting schedule determines when the SARs become exercisable. SARs usually follow a graded vesting schedule where portions vest over time. The key sub-parts of this are:
Vesting start date
Total length (e.g. 4 years)
Vesting frequency (e.g. monthly, quarterly, yearly)
Cliff/no cliff
And in less common cases, other items like staggered schedules or acceleration may apply
IMPORTANT: Vesting schedules can (and frequently do) vary in many ways. For more information and examples see: Vesting Schedules
Cliff Vesting ("Cliff")
A cliff is built into the vesting schedule, functionally modifying it so that no shares will vest until a minimum amount of time is met (i.e. the cliff time period). For new hires, a 1-year cliff is very common.
Why do companies use cliffs? Stock-comp is intended to incentivize employees to add value to a company. Cliff's help ensure a long enough tenure to add such value.
Expiration Date
The expiration date is the last day on which the vested SARs can be exercised. Typically, the expiration date is 7 to 10 years after the vesting start date. SARs that are “in the money” must be exercised before expiration to avoid forfeiture.
How Do SARs Provide Employees With Value?
Companies grant SARs to give employees (or other individuals) the opportunity to financially participate in the company’s success. For SARs, an individual has the right to receive payment on an increase in the stock price, without a requirement to pay to purchase shares.
If the company’s share price appreciates, the SAR (via its fixed purchase price) provides a financial benefit. Your SAR is “in the money”, and you would be owed a contractually-determined amount of remuneration from the company if you exercised the SAR.
If the company’s share price depreciates, the SAR provides no financial benefit. Your SAR is "underwater" and currently has no exercisable value. If the share price stays below the fixed price on your SAR, it will expire worthless on the expiration date
Exercising SARs
Once an employee's SARs have vested, they become eligible to be exercised. The process of exercising SARs typically involves the following steps:
Notify the company. When an employee wishes to exercise their SARs, they must first notify the company according to the procedures outlined in the SAR plan. This often simply involves submitting an exercise notice to the appropriate department
Receive payment (net of tax). After notifying the company, the employee will typically receive a cash payment for the exercised SARs within a set time frame. The payment amount will be contractually determined, based on the difference between the SAR grant price and the stock price on the exercise date. Last, SAR compensation is taxed as ordinary income, and tax withholdings are required; as such, the payment to the employee would be net of withholding tax.
SAR Benefits, Drawbacks, and Less Common Elements
SARs provide the opportunity to share in a company’s success. If the company’s stock price rises above the exercise price, employees can request to exercise their vested SARs and receive a cash payment.
Employees have the right but not the obligation to exercise. Employees can decide when to exercise based on their own financial and tax situation. Employees have considerable control over certain timing elements.
SARs provide a cash payout; employees do not have to purchase and sell stock to realize value. The company simply pays out the contractually calculated amount for the exercised SARs.
SARs can provide incentives without equity dilution. SARs do not grant actual stock so they do not dilute shareholder equity.
Tax Implications of SARs
SARs confer to the grantee a choice of when to exercise, and thus the owner has a reasonable degree of control over the timing of taxation (i.e. when they choose to exercise). Otherwise, taxation is relatively straightforward:
Non-taxable at grant and vesting. SARs do not trigger any tax implications when they are granted to an employee or when they vest.
Ordinary income tax treatment when exercised. When an employee exercises their SARs, the FMV of the stock must be above the strike price of the SAR (otherwise, the SARs are not exercisable). The difference between the FMV of shares when exercised and the strike price is taxed as ordinary income.
Related Pages
🔗 NSO Planning/Strategy (as noted; SARs are similar to NSOs in many ways)
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