SAR or Stock Appreciation Right – Complete Guide

Stock appreciation rights (SARs) are employee remuneration based on the company’s stock price over a defined period. SARs are similar to employee stock options (ESOs), except they are advantageous for employees when the company’s stock price increases. However, with SARs, employees are exempt from paying the exercise price. Instead, they are paid the difference in stock or cash. This article explains the procedure for granting SARs to employees, types of SAR, and SAR vs stock options.

Stock Appreciation Right or SAR

A Stock Appreciation Right (SAR) is a benefit that entitles the holder to financial gain from the increase in value of a predetermined number of shares of the company’s stock over a predetermined period.

What is SAR?

SAR is a technique for awarding bonuses to staff members in the form of shares rather than cash. SARs are advantageous to employees when share prices rise in the future. Depending on the scheme, the employee receives either shares or cash equal to the net rise in share price. Employers benefit from SARs because they do not have to dilute their share price by issuing extra shares.

Example of SAR

Consider an employee who receives a performance incentive of 300 SARs. Additionally, assume that the SARs reach their maturity after two years.

Over the next two years, the company’s stock goes on to rise by $45 per share. As a result, the employee receives an extra $13,500 in pay (300 SARs x $45 = $13500).

These SARs could also have a clawback clause, in which employees lose them if they leave the business before the two-year time is up.

How does SAR work?

Stock appreciation rights grant the right to the monetary equivalent of an increase in an equity share’s price over a set period. These bonuses are nearly always paid out in cash by the employer. However, the employee incentive may be paid in stock. Employees can often exercise SARs once they’ve vested. When SARs vest, they only indicate they are now available for exercise. In addition to stock options, employers frequently grant SARs.They aid in financing options acquisition and assist in paying taxes owed when the SARs are exercised.

SARs are transferable and covered by a policy against clawbacks. An employee’s bonus or any other incentive-based compensation under a plan may be recovered by the company following the terms of a clawback policy, regardless of whether the provision is applied retrospectively or prospectively.

Types of SAR

Stock appreciation rights can be classified into three types. They are full-value SARs, phantom SARs, and tandem SARs.

Full-value SARs

Full-value plans pay the underlying stock’s value along with any appreciation. It shares many characteristics of traditional non-qualified plans, including the potential for discrimination and the typical existence of a significant risk of forfeiture that vanishes upon the payment of the benefit to the employee.

Example: Mary works for a publicly traded company and has been granted 2,000 Full Value SARs as part of her compensation package. At the time of the grant, the current market price of the stock is $75 per share. The SARs have a vesting period of 4 years.

• Year 1: Mary is granted 2,000 Full Value SARs with an exercise price of $75 per share.
• Year 2: After the second year, her SARs are still vesting, and the market price of the company’s stock has increased to $85 per share.
• Year 3: The third year passes, and the stock’s market price has further increased to $95 per share.
• Year 4: Mary has now completed the full 4-year vesting period, and the market price of the stock is $110 per share.

At the end of the fourth year, having completed the vesting period, Mary chooses to exercise her 2,000 Full Value SARs. With Full Value SARs, she receives the entire appreciation in the stock’s value over the vesting period. Here’s how her profit is calculated:

Appreciation = $110 – $75 = $35 per share

Total Profit = Appreciation per share * Number of SARs

Total Profit = $35/share * 2,000 SARs = $70,000

So, by exercising Full Value SARs, she would receive $70,000 in cash or company stock as a result of the stock’s appreciation during the vesting period. This provides a financial incentive for employees to stay with the company and benefit from the stock’s growth.

Phantom SARs

It offers employees a cash award equal to a certain number or percentage of the company’s stock with the current share price. The award amount is typically maintained as fictitious units (phantom shares) that approximate the stock’s price. These plans are often designed for senior executives and critical staff and can be extremely flexible.

Example: In recognition of Emma’s contributions to the company’s financial success, the company, which she works for, wishes to reward her. They offer her 1,000 Phantom SARs rather than actual business shares, which might dilute current shareholders or complicate the ownership structure. At the time of the grant, the stock price was $50 per share, and these Phantom SARs have a three-year vesting period.

Over the next three years, Company’s stock price experiences increases. Emma makes the decision to use her Phantom SARs at the conclusion of the three-year vesting period. For each SAR, she is entitled to the cash equivalent of the increase in stock price from the grant price to the current market price:

When Emma exercises her Phantom SARs, she receives cash payments depending on the improvements in stock price over the course of the three years for each SAR. In total, her cash payout for all 1,000 Phantom SARs is:

$10,000 (Year 1) + $20,000 (Year 2) + $30,000 (Year 3), totaling $60,000

This payment links Sarah’s interests to the company’s stock performance without requiring her to hold any actual shares, making it an important part of her income.

Tandem SARs

Tandem stock appreciation rights are SARs issued in conjunction with an incentive or nonqualified stock option and expire when the other option expires or is exercised. The holder will have to decide between exercising the underlying option to purchase shares of stock and surrendering all or part of that option in exchange for an appreciation payout.

Example: Emily, one of the Company’s top executives, receives a compensation package that includes 1,000 Tandem SARs and 1,000 stock options. The prevailing market price of the company’s stock at the time of the grant was $40 per share, and the exercise price of the stock options is $40 per share as well.

Over the next three years, Company’s stock price experiences increases.

Over a three-year period, Company XYZ’s stock price experiences the following changes:

Let’s examine how Tandem SARs function in combination with stock options:

Together with the money Emily made from the stock options, the Tandem SARs allowed her to earn an extra $16,250 in cash over the course of three years (500 SARs x $10 + 250 SARs x $20 + 250 SARs x $25). Without having to directly hold shares, tandem SARs give her a useful opportunity to connect her interests with the success of the company and profit from increases in stock price through either the stock options or the SARs.

Granting SARs to Employees

Grant is an arrangement by which the employer offers the employee the choice of benefits or SARs. The employee is entitled to receive the benefit that was given upon vesting.

SARs are granted at a defined price, similar to stock options, which is used to determine the appreciated value at the time you acquire them.
SARs frequently feature an expiration date as well as a vesting term (i.e., vesting signifies ownership, a waiting period before receiving the award ownership). Employees can use a SAR at any time before the expiration date after it has vested.

Exercising SARs

An employee may exercise a SAR at any time before it expires once it has vested. Depending on the terms of an employee’s plan, the proceeds may be paid in cash, shares, or a combination of cash and shares.

Employees do not need to make any upfront payments in order to get the awards, in contrast to stock options, which demand that employees pay an exercise price (also known as a purchase price).

Advantages and Disadvantages of SARs

SAR is a tool for employee motivation that offers extra rewards above and beyond regular pay that are linked to a company’s performance and aid in retaining staff members.

One advantage is the ability to exercise options and receive monetary rewards without making an upfront payment. Another benefit is the ability to customize SARs to the beneficiaries’ needs. Companies with SAR plans can choose which employees receive benefits, how liquid the SARs are, how much bonuses are worth, and the ideal vesting schedule.

On the downside, tandem SARs might have a detrimental effect on a company’s stock price similar to how straight stock options would, as they would increase the number of shares outstanding, which would lower earnings per share.

Tax Implications of SAR

The taxation of SARs is the same as that of NSOs, or non-qualified stock options. There are no tax implications on the grant date or when they are vested. Participants must, however, recognize ordinary revenue on the spread at the time of exercise. Most employers will also deduct additional federal income tax. They will also set aside money to cover local and state taxes as needed.

Taxation of SARs for Employer and Employee

Stock Appreciation Rights (SARs) have distinct tax implications for both employees and employers. When an employee is granted SARs, they typically won’t incur immediate U.S. federal income tax consequences. However, when they decide to exercise the SARs, taxation comes into play. At that point, the employee must report compensation income based on the fair market value of the vested portion of SARs.

On the other hand, employers have their share of responsibilities regarding SARs. Employers are tasked with the administrative duty of withholding tax on the compensation income recognized by employees during SAR exercises. The withheld taxes must be collected and remitted to the Internal Revenue Service (IRS) in accordance with tax regulations.

These tax procedures are crucial to ensure compliance with U.S. tax laws and to account for SAR-related income and taxes properly.

Withholding Requirements

Most employers will also deduct additional federal income tax. They will also set aside money to cover local and state taxes as needed. Taxes on SARs in the form of shares are frequently withheld by employers as well. For instance, a company might only provide a specific number of shares and withhold the rest to pay the tax. Similar to NSOs, when holders sell their shares, the revenue received upon exercise constitutes the cost basis for taxation.

SAR vs Stock Option: Which is Best for you?

Stock Appreciation Rights (SARs) closely resemble stock options, with a notable distinction. In the case of stock options, employees must exercise them by purchasing the underlying security at the grant price. Conversely, SARs offer a unique advantage – when exercised, employees are not required to buy the underlying security. Instead, they receive the monetary equivalent of the appreciation in the security’s value, calculated as the current market value minus the grant price.

Also, SAR plans have a number of benefits over other stock compensation options, the loss of the qualified stock options’ favorable tax treatment makes SARs a desirable form of remuneration for employees. It also has simpler accounting regulations than other types of equity compensation. This simplifies the process for employees and can make SARs an appealing choice.

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A stock appreciation right (SAR) benefits employees as the business stock appreciates in value over time. It’s simple to record all equity transactions, and the additional features, such as waterfall analysis and round modeling, aid in the decision-making process for the succeeding financial rounds. You can issue shares, keep track of them, and manage everything in one location with Eqvista. You can add shareholders to see their shareholdings; everything is tracked in real-time. Click here to access the application and start using it right away! Feel free to contact us anytime!