Equity Incentive Arrangements Types Intro--04 Stock Appreciation Rights (SARs)

Stork Appreciation Rights are essentially bonus programs that give grantees the right to receive stock or cash (more commonly used) based on the increase of share value over time. Compare to restricted stocks and stock options, SARs are less commonly used by startups.

*SARs value = FMV at time of exercise – exercise price

Mandatory requirement: exercise price = FMV on date of grant (otherwise may subject to IRC section 409A regulation)

Tax treatment: value upon payment = ordinary income; deductible for the startup

Key Advantages:

• Convenient for grantee (no need to pay to buy startup stocks = no cost no risk)

• Cash-settled SARs are non-dilutive to the other startup shareholders

• Stock-settled SARs are less dilutive than stock options (because only the number of shares equal to the spread/increased value need to be issued on exercise)

Key Disadvantages:

• For startup-employers, large cash payments to employees may disrupt the startup's cash flow

• For grantee-employees, payments must be taxed as ordinary income rather than capital gains

• No or less stock = no or less voting power

• Fair Market Value for startup stocks is usually very hard to establish, especially when premature exercise (SARs not fully vested) happens due to early termination (for good or bad cause).

**This blog provides general information for educational purposes only. It is not intended to constitute specific legal advice and does not create an attorney-client relationship.