Startup Compensation: How do Stock Appreciation Rights (SARs) Work?

"My employer is utilizing stock appreciation rights as his way of providing equity/compensation to employees at our startup, and I'm wondering how they work. Examples and scenarios would be helpful." Link here for full answer thread on Quora: http://www.quora.com/Startup-Compensation/How-do-Stock-Appreciation-Rights-SARs-Work/answer/Dan-Walter?__snids__=187515030&__nsrc__=4

Dan's Answer:

Stock Appreciation Rights (SARs) work much like a stock option, as far as delivering value. They offer upsides and downsides. Essentially you are given a right to any appreciation in company stock above the value on the date it was granted to you.

The big difference is in how this value is delivered. With a stock option you pay an exercise price (and perhaps taxes) and get the full number of shares associated with your grant.  With a SAR you simply get the net value at the time of exercise.  Usually this net value is delivered in cash, sometimes in stock. These have less of an ownership dilution effect because fewer, or even no, shares are issued.

They work well for S-Corps who are limited in how many shares they can have. They also work great if a company is trying not to give away too much of the ownership (by choice or because they have none left to give.)

Example.  Current company stock price $1.00.  You receive 300 SARs.  The company Value goes to $5.25 and you exercise. You get $4.25 for each SAR exercised.  This in considered Ordinary Income and would be subject to tax withholding (so subtract another 30-40%).

From my document "Compensation Tools for Private Companies" (available upon request)

"Stock Appreciation Rights (SAR) Stock Appreciation Rights provide the holder with the right to the appreciation on the underlying stock at a later date, based on a price that is preset at the time of grant. Typically the base price is set to 100% of the fair market value on the date of grant. SAR holders can choose when they would like to exercise their rights, generally any time after the SARs are vested. A company must determine a “fair value” using an option-pricing model to determine the compensation expense associated with each stock option share. The compensation expense is amortized over the vesting schedule of the rights. SARs can be settled in either cash or stock. If settled in cash they are treated as a  liability for accounting purposes and are subject to mark to market accounting. If settled in stock they are treated, for accounting purposes, in the same manner as stock options."

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