What is a Stock Appreciation Right?
SARs are a contractual promise by a company to give the recipient an amount of cash (or stock-equivalent, which is less common) equal to the appreciation in the value of the company’s stock between the SAR grant date and the SAR exercise date. As with other equity compensation, SARs are often subject to vesting.
Alternatively, you can think of SARs as pseudo cashless-exercise options in that like an option, the recipient must exercise the SAR, but unlike an option, the recipient doesn’t need to pay the exercise price for the options and instead immediately gets the difference in cash (or stock-equivalent) between the SAR exercise price that was set at grant and the fair market value (FMV) of the SAR when exercised.
SARs are also sometimes paired with options in what’s known as a “tandem SAR,” which enables the tandem SAR recipient to use their SAR proceeds to pay for options.
When dealing with taxing SARs, there are 4 phases to consider with taxes – at the time of grant, vesting, exercise, and sale of the underlying stock.
1. At grant, a SAR is not taxed.
2. At vesting, a SAR is also not taxed.
3. At exercise, an SAR is taxed as ordinary income equal to the FMV of the cash (or stock) received.
4. At sale of SAR stock (only applicable in the case of SAR with stock), the recipient realizes capital gains/losses between the sale proceeds and the stock's FMV at the time of sale.
As with RSUs, SARs may seem amazing for recipients because they do not need to pay for exercise.
However, as with RSUs, SARs are typically reserved for late-stage/mature private companies because if the SAR is settled with cash (i) a company needs sufficient cash-flow to cover payments of stock and (ii) then there is no further upside for the recipient which is one of the main potential benefits of early stage company stock. Furthermore, early stage company equity is often cheap enough that it’s simpler for the company to just offer options with a low exercise price, while the company’s employees can also benefit from the potentially more tax advantageous incentive stock option.
