A Guide to Stock Appreciation Rights (SAR)

In the June edition of Fables Of ESOP, we covered an article on Nuclei which talked about Stock Appreciation Rights (SARs) as a form of equity linked compensation to its employees. While I had read about SARs, I hadn’t come across a startup which had actually issued it.

Furthermore, I found Nuclei’s plan details quite interesting to explore more — for starters, Nuclei has allocated SARs worth 25% of the company’s valuation (which is a large-ish pool than the ones you find in the ESOP world) — which is valued at about 25CR currently allocated to about 60 employees. Additionally; there are periodic liquidation events that Nuclei plans to execute to buyback SARs from its annual profit pool going forward.

This got me curious to know more and reachout to Ankur Joshi and he was kind enough to give me sometime to talk about Nuclei, his larger compensation philosophy and all aspects about SARs.

Here’s what we cover during the interaction:

• Introduction about Nuclei
• Why did he choose SARs as an instrument to reward employees?
• How does it compare with ESOPs (SARs vs. ESOPs)
• How do SARs work? How do employees get upside with SARs?
• How are the SARs valued among many other questions.

Do read the blog further for excerpts and do watch the full interaction here:

About Go Nuclei — Delivering Consumer Tech DNA to Banks through its SaaS platform

Before we spoke about Stock Appreciation Rights (SAR), we did take a few minutes to talk about Nuclei and what does it do.

About Nuclei

Having been a serial entrepreneur, Ankur spoke about his urge to build something sustainable and something long-term from day 1 as part of his next entrepreneurial venture. While researching about sectors, they realized that banks have traditional lagged behind in adopting the new-age tech that you find in other consumer-tech startups. And hence the concept of delivering a consumer tech DNA through Nuclei.

Nuclei has created a SaaS platform that helps banks to provide multiple 3rd party products to their customers directly from their mobile application and increase customer engagement on their apps.

Nuclei currently works with 18 banks right now with two major product lines: a) a merchant market place and b) a digital banking solution.

Why Bootstrap?

Ankur underlined that when they started Nuclei, they wanted to think long term and not worry about immediate runway for the next 12 months. Fortunately, the choice of their problem and the solution that they were building didn’t require large amounts of risk capital upfront. Thus, they wanted to get outside of survival mode and take bold decisions which are longer term in terms of clients they want to work with, geographies they want to enter and product decisions they take. Wanted independence in taking some of these decisions.

Philosophy about Equity linked compensation for Employees

Ankur shared his guiding principles in coming up with a compensation policy that is linked to the larger vision of the organisation they as co-founders wanted to build:

• Thinking long term
• Building a great organization and a great product need great people
• Product Thinking in Building a Team!

Founders are the Product Managers of their teams. Hence you need to think of adding new features and making it better every year. — Loved this analogy! :)

What is an SAR? And why SARs over ESOPs?

While ESOPs are options that employees get to purchase shares at a pre-determined price at some point in the future. Once shares are purchased, employees can liquidate their shares through a secondary sale or company buyback. Hence it’s a two step process

Stock Appreciation Right is a signed contract between the company and an employee and is a liability that the company takes up to reward its employees with the value of stock appreciation — that is the difference between the stock price at the time of exercise vs. at the time of allotment of SARs.

Advantages of ESARs over ESOPs?

One step process vs. Two Steps

In SARs there is only one step to liquidate (employees can get cash compensation by exercising their vested SARs) vs. in ESOPs — you first have to exercise your vested options and then sell your shares.

No upfront cash implications for Employees

One of the major reasons why employees lapse or forfeit their ESOPs is because they need to pay upfront price to exercise options and also additionally pay tax as perquisite (treated as income) even before they realize any upside or cashflow. This is avoided in SARs as the employee doesn’t have to pay any exercise price but rather gets the delta of the price difference as a bonus income. This avoids the hassle of allocating any upfront cash to exericse the options. On the taxation front, the employee only pays tax on realizing the cash and hence its easier to payout the tax from the appreciation pool you make.

SARs have flexibility in Structuring vs. ESOPs that are regulated

SARs at the end of the day are contractual obligations between company and employee and can be creatively drafted in a custom way to suit the company’s needs. While ESOPs are standard instruments and need to be complied with the prevalent regulation. For eg: Cliff, who can be given ESOPs, rules around vesting, exercise etc.

How does Vesting and Liquidity Event work in SARs?

Ankur mentioned it depends on the company. At Nuclei they intend to do buybacks every 6 months starting September of this year from the profits Nuclei makes each year. He also mentioned they are quite democratic in their decision making and will continue to experiment on the frequency of buybacks based on the feedback.

Vesting works similar to ESOPs in the sense based on the vesting schedule — which could be time based or performance based SAR units can be vested by employees which are ‘earned’ for the employee to exercise in the next liquidation event.

How is pricing of the stock decided to provide liquidity to SAR holders periodically?

Ankur mentioned that in the absence of a market led pricing, they depend on external valuation on a realistic basis based on the performance of the company. One way to think about is if the company were to be sold tomorrow as a going concern what would they be valued at. Ankur mentioned, they’ll stay away from ‘frothy’ valuations that are based on investment ticket sizes. Rather they’ll go back to the basics to arrive at a realistic valuation that incrementally makes sense and reflects the growth of the organization.

Why did you allocate 25% of your current valuation to your SAR pool?

While Ankur mentioned there is no scientific reason for the pool size, the rationale was to allocate a sizeable pool and they felt 10% was too small that is typically allocated. And as a company which is people oriented for the longer term, 25% felt right.

Engagement with Employees on SARs

Ankur underlined the importance of effective communication with employees. Ankur feels it is the founder’s responsibility to explain the instrument and what it means to the employees. Ankur went onto describe the collaborative process he adopted at Nuclei to compare ESOPs and ESARs through an FAQ document and discussed it openly within the organization and arrive at ESAR approach as the most preferred by the employees.

Parting thoughts from Ankur as advise to First Time Founders

• The team in a startup is founder’s greatest product
• Hence, founders need to prioritise finding the right set of People to work with
• Don’t hesitate to share a sizeable chunk of your ownership

Hope you enjoyed reading about Ankur’s journey with Nuclei and getting a practical primer on SARs from him. If you have any questions for Ankur.

PS: And if your startup needs help in setting up their ESOP/SAR/Phantom Stock plan and managing it through an automated system, do refer them/reach-out to us at Qapita :)

srikanth@qapitacorp.com

Connected with me: LinkedIn; Twitter

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