How to reward your employees through stock appreciation rights

For a lot of companies it is a challenge to attract the best and brightest employees and to keep them on board once they’re in. For top talent, a simple monthly pay check just isn’t enough. And sometimes entrepreneurs in a startup fase, due to a lack of funds, are forced to come up with alternative solutions to compensate their key staff in the right way.

In these cases, granting employees shares in the company can be interesting. However, this generally means that employees will also have voting rights or will have to join a shareholders agreement, which isn’t always desirable. You can circumvent this by issuing shares in the form of certificates, allowing employees to enjoy only the economic rights of the shares and not the control/voting-part. Both instruments however can cost a lot of money and will yield a lot of paperwork. The solution can be found in Stock Appreciation Rights (or SAR, sometimes share appreciation rights).

What are Stock Appreciation Rights?

The idea of Stock Appreciation Rights is that an employee obtains, rather than a certificate or a share in the company, a claim against the company that is linked to the increasing value of the company and its shares. A virtual share, in a way. It works like this. At the moment that the SAR are assigned to the employee, the value of the Stock Appreciation Rights is calculated according to a certain formula. For example, the employee gets Stock Appreciation Rights corresponding to 1% of the shares in the company, which is currently valued at € 1,000,000. If the parties decide to end their relation after five years, the employee decides to exercise his Stock Appreciation Rights. According to the same method of valuation, the company is now worth € 3,000,000. While 1% of the shares were worth € 10,000 at first, they are now worth € 30.000. The employee is entitled to the (positive) change in value, which comes to € 20,000 in this example. A nice bonus!

Flexibility

In the agreement you can make different arrangements about the actual implementation. For instance, you can agree that the Stock Appreciation Rights can only be exercised in the case of an exit (acquisition or IPO), instead of the option in the example, where the SAR were exercised after the employment came to an end. You can also agree that vesting is applicable. That way, the employee will obtain the Stock Appreciation Rights over the course of a couple of years, so that he or she can exercise 100 % of the rights only after five years. If employment ends after four years, then he or she is only entitled to 80% of the Stock Appreciation Rights that employee would have otherwise been entitled to, if he or she had remained with the company for the full five years. It is also always good to idea to agree on a clause that forces an employee to transfer the Stock Appreciation Rights back to the company at no cost in the event of a bad leaver (the employment agreement is terminated by the employer for urgent reasons). It is also possible to make arrangements to pay dividends.

Tax benefit

Stock Appreciation Rights can be a flexible way to reward employees, with relatively little paperwork and low costs involved. In addition, there is also a tax break for employer: the cash payment to the employee is deductible to the profits. This, for example, in contrary to the granting of stock options to employees. For employee, the cash payment is subject to normal income tax.

So, consider Stock Appreciation Rights if you want to have your employees share in the success of your company!

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Stock Apprection Rights voor werknemers door Boris van der Assen

Boris von der Assen

Attorney-at-law

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