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Definition of Stock Appreciation Rights (SARs)

Stock Appreciation Rights (SARs) are a type of phantom equity where startup employees are granted the right to receive the increase in the value of a specified number of company shares over a predetermined period of time, without having to actually own the shares. Upon exercise, employees receive a cash payment equal to the appreciation in the stock's value. Below is a more detailed breakdown of important features of SARs and how they work:

  1. Exercise Price: This is the price of the company's stock on the grant date. It serves as the baseline for determining the appreciation of the stock.
  2. Vesting Period: Just like stock options, SARs often come with a vesting period. This means that the employee must remain with the company for a certain period before they can exercise their SARs.
  3. Exercise: When an employee exercises their SARs, they receive the difference between the current stock price and the exercise price. For example, if the exercise price was $10 and the current stock price is $15, the employee would receive $5 for each SAR exercised.
  4. Settlement: SARs can be settled in the form of company stock or cash. If settled in stock, the employee receives the equivalent value of the appreciation in shares. If settled in cash, the employee receives the monetary value of the appreciation.
  5. Advantages:
    • For Employees: They can benefit from the appreciation of the company's stock without having to purchase any shares or spend any money upfront.
    • For Employers: SARs can be a way to incentivize and retain employees without diluting the company's stock, especially if the SARs are cash-settled.
  6. Taxation: The taxation of SARs can vary based on the jurisdiction and the specific terms of the SAR agreement. Generally, in the U.S., the appreciation is treated as ordinary income at the time of exercise.
  7. Difference from Stock Options: While both SARs and stock options give employees the opportunity to benefit from the appreciation of the company's stock, there are key differences. With stock options, the employee has the right to buy the stock at a predetermined price, whereas with SARs, the employee simply receives the appreciation without having to buy the stock.

In essence, SARs offer employees a way to participate in the company's growth and success without the need to own or purchase actual shares.