A brief guide to stock appreciation rights (SARs)

With the rise in the startup industry, almost every startup recognises the importance of setting up an employee benefit structure in place so that they can adequately incentivise their people for the growth the company has achieved. Widely used share-based remuneration systems in companies are stock options and SARs. While both employers and employees acknowledge that employees should be adequately rewarded, there is a huge information gap at the hands of both parties, and they are not aware of which of these to use.

In this blog, we will cover what SARs are, how they work, how they compare to stock options and more.  

What are stock appreciation rights (SARs)?

Stock appreciation rights (SARs) are a type of equity-related compensation that allows employees to benefit when their company’s share price increases, without having to buy the shares themselves. Unlike stock options, SARs usually do not require payment of an exercise price. Instead, employees receive the value of the increase in the company’s stock price over a certain period, which may be paid out in cash or shares. Because of this structure, SARs can be an attractive incentive for employees while also helping companies limit the dilution of existing shares.  

Companies often issue SARs to employees alongside their regular pay or in lieu of stock options. Sometimes, SARs come with stock options, too. When this happens, employees can use SAR proceeds to help pay for their stock options.

SARs vs phantom shares:

Phantom stock and stock appreciation rights (SARs) are often seen as similar, especially by those exploring equity compensation for the first time. Both are designed to reward and motivate employees without granting actual ownership in the company. However, despite these similarities, there are key differences in how they operate and are structured, making it important for companies to understand which option best fits their needs.  

While they may seem alike at first glance, a closer comparison highlights the distinct features of Phantom Stock and SARs.

SARs vs stock options

While both SARs and stock options are designed to incentivize and reward employees, they function in different ways and provide distinct advantages.

Here are the key differences between them.

SARs vs RSUs

Here are the differences between SARs and RSUs.

How do stock appreciation rights work?

In most companies, stock appreciation rights (SARs) are administered by the compensation committee (CC), a committee formed by the company’s board of directors. Here is the step-by-step process for implementing SARs.  

To begin the SARs process, board approval is required. The company’s board of directors must first approve the plan, which includes determining eligible employees, typically based on factors such as role, performance, and tenure.  

• Vesting: Stock appreciation rights (SARs) generally vest over a period of one to four years, with a common structure being a one-year cliff followed by monthly or quarterly vesting thereafter. Since the plan is flexible, the vesting schedule and other terms can be tailored to each employee, helping align the program with both company goals and employee expectations.  

• Exercising SARs: Depending on the plan's terms, employees may choose when to exercise their vested SARs during the exercise window. When they do, they receive a cash payment equal to the increase in the company's stock price from the grant date, subject to applicable taxes and deductions  

• Event-triggered exercise: Some SAR plans tie exercise to a specific trigger, such as a performance milestone or a liquidity event, rather than leaving it to the employee's discretion. If the stock price has increased by that point, the employee receives a payment based on that increase.  

• Exit scenario: In special cases, such as a company exit event, the process changes. If a merger, acquisition, or IPO occurs, the SARs may become fully vested immediately. The employee is then entitled to a cash payment equal to the increase in the stock price since the grant date.

For unlisted (private) companies, the process is generally simpler and less regulated. These companies have greater flexibility in designing their SAR schemes, they can grant SARs not only to employees but also to third-party participants such as consultants and may offer them at different prices to different individuals. Unlike listed companies, unlisted firms are not required to set up a mandatory vesting period or establish a Compensation Committee; the board of directors can administer the scheme directly.

What are the different types of stock appreciation rights?

Stock appreciation rights are generally classified into two types.  

• Stand-alone stock appreciation rights: They are granted as separate compensation instruments. They are issued separately and are not linked to or combined with stock options.  

• Tandem stock appreciation rights: They are granted together with either a non-qualified stock option (NSO) or an incentive stock option (ISO). This means the holder can use the benefit by exercising the stock option or the SAR. However, once the holder chooses one of these options, the other cannot be exercised. In other words, selecting one form of exercise automatically excludes the other.

How are stock appreciation rights taxed?

Getting a stock appreciation right (SAR) does not create a tax bill. Just like regular stock options, you don't have to report anything to the IRS when you first get the SAR.

When SARs are exercised, the difference between the market price at the time of exercise and the market price at the grant date is multiplied by the number of SARs exercised, and this amount is treated as ordinary compensation income. This amount is subject to income and payroll taxes.  

In many cases, the plan’s terms require automatic withholding of taxes from the cash proceeds upon exercise of SARs. The employer calculates the required federal income and payroll taxes based on the compensation value realized from the SARs and directly withholds this amount before distributing the net proceeds to the employee.

Example of stock appreciation rights (SARs)

XYZ Corporation granted stock appreciation rights (SARs) on January 1, 2012, when its share price was $15. The vesting date, when the employee becomes eligible to exercise these rights, is January 1, 2022.  

Emma received SARs tied to 120 XYZ shares. On the vesting date, XYZ’s share price is $75. The value of Emma’s SARs is $7,200 [($75 – $15) × 120].  

At this point, Emma has two choices: she can either receive the $7,200 as a cash payout or opt to settle the SARs in shares of XYZ stock, which would be equivalent to 96 shares ($7,200 ÷ $75).

What are the stages of stock appreciation rights?

What are the advantages of stock appreciation rights?

Here are the advantages of stock appreciation rights.

• Flexibility: One of the biggest advantages of SARs is their flexibility. Companies can design them in different ways to suit the needs of various employees. However, this flexibility also means that several decisions need to be made. For example, companies must determine who will receive SARs, how much they will be worth, when employees can convert them into cash or shares, and the conditions under which they will vest.

• Cost-effective incentive: Startups can use SARs to attract and motivate employees without needing immediate cash. Upon vesting, companies may owe cash if shares rise.

• Simpler cap table: SARs keep the cap table simpler than stock options. When employees exercise stock options, they receive shares and become shareholders, which are added to the cap table. SARs provide the value of share appreciation without issuing shares.

• Simpler accounting: SARs usually have simpler accounting than other forms of stock compensation, making reporting easier.

• No capital at risk: Unlike stock options, employees pay nothing upfront to receive SARs. If the stock price does not rise, they receive no payout, but they lose nothing either

• Motivation tool: SARs motivate employees to focus on company growth and reward them when the company's value increases.

What are the disadvantages of stock appreciation rights?

Here are the disadvantages of stock appreciation rights.

• High-risk compensation: SAR payouts depend on the company's stock price rising. Employees get nothing if the share price stays flat or drops, making SARs less appealing to those unsure about the company's future.

• Regulatory compliance: SARs are subject to several regulations and may be reviewed by the IRS. Private companies lacking resources or expertise may encounter legal and financial risks.

• May create liquidity pressure: SARs can strain cash flow, especially if many employees exercise them after a stock price surge, causing significant payout burdens.

• Company culture fit: SARs may not align with every company’s culture. Some founders prefer traditional equity or other incentives when employee ownership matters more.

• Complexity: Stock Appreciation Rights (SARs) can be difficult for employees to fully understand, which may create confusion or dissatisfaction. Without clear, effective communication, the program may negatively affect employee perceptions and company culture.

How can you implement a SAR that is both efficient and transparent?

With Qapita’s powerful equity management platform, you can design and issue digital SARs, manage grants seamlessly, and keep every stakeholder aligned through a single, transparent system. From grant creation to employee transactions, Qapita streamlines the entire SAR lifecycle, making employee rewards easier to manage and more transparent than ever. Book a demo today!

Frequently asked questions on stock appreciation rights

What is the difference between stock options and stock appreciation rights?

Stock options give employees the right to buy shares at a fixed price, so they benefit from both the appreciation and the full value of the shares. SARs only deliver the increase in share value, typically as a cash payment, with no requirement to buy shares. SARs are simpler and carry no upfront cost to the employee

Do stock appreciation rights expire?

While expiry periods vary by plan, SARs commonly expire 7–10 years from the grant date. If you do not use them before they expire, they become worthless. Leaving your job, retiring, or passing away can also change the timing of your benefits.

What happens to your stock appreciation rights if you leave your employer or retire?

If you leave your employer, stock appreciation rights usually expire sooner. If you retire, you can keep any vested rights, but you may have less time to use them. Check your employer’s rules for exact details.