Everyone has their own unique language. Full of common phrases we’ve picked up (and misheard) over the years, we have a vocabulary as distinctive as our fingerprints. Industries have it too, but at scale.
Go to a conference in a speciality you have no knowledge about, and you can overhear conversations that might be in a different language. Acronyms will fly, jargon will bombard the brain, and entire new words will appear as if from thin air.
The world of stocks, shares and equity is no different. Options, phantom shares, buying a put option, selling a call option, restricted stock… it’s a familiar story for the non-expert trying to get the information you need.
Today, we’re going to try and simplify two pieces of the puzzle that are often confused – Stock Appreciation Rights (SARs) and Stock Options; how they’re different and who they work best for.
What are Stock Appreciation Rights (SARs)?
When thinking of Stock Appreciation Rights, always focus on the ‘Appreciation’ part. That’s because SARs are rewards based on the appreciated value of a stock option, and not an actual stock option itself.
In other words, if you’ve been awarded a SAR you will be paid the difference between the stock price at the time they were given to you and the price at the time you get them (usually in the form of a bonus). Of course, this only works if the price of the stock rises.
In practical terms, let’s imagine Jane is given 100 SARs. At the time she was given them, the stock price was $50. By the time the scheme ends, the stock price has risen to $66. That means each SAR will be worth $16 – the difference in price from the start of the scheme to the end – meaning Jane will be awarded $16 x 100 = $1,600.
And they are usually paid out in form of a cash bonus, although sometimes they are given in the form of shares.
So, what are the advantages of Stock Appreciation Rights? Let’s look from the employer perspective first.
Benefits of Stock Appreciation Rights (SARs) to employers
Stock Appreciation Rights give employers a great deal of flexibility when designing their plan
The benefits of SARs for employers can be summed up in a few words; flexibility and less dilution of shares. This is without taking into consideration the primary aims of employee equity compensation – motivating, retaining and attracting talent.
One of the great benefits for employers when it comes to SARs and incentives is the flexibility they give you. You can structure your plan in a wide range of ways to suit different individuals with different motivations. However, this flexibility does have an inherent downside – if the stock price doesn’t appreciate then the SARs can be worthless, no matter how they are structured.
SARs also help employers by reducing the dilution of shares. Because the plan is based on the appreciation in value, the employer doesn’t have to issue additional shares.
Benefits of Stock Appreciation Rights (SARs) to employees
The biggest benefit for employees when it comes to SARs is that they don’t have to invest their own earnings to buy stock (or stock options) in the first place.
Employees will benefit from the SARs when the company’s stock price rises and they receive the sum of the increase in stocks or cash (usually the latter). However, if the stock price doesn’t rise, then the promised reward won’t materialise.
In other words, employees don’t take any real risk with Stock Appreciation Rights but are also subject to stock market fluctuations.
What are Stock Options?
Stock options are essentially the right of someone to buy shares at a determined price during a defined period of time. It’s like if your local computer store said that you could buy 10 laptops for 10 dollars in the next seven days. On day eight, the option for you to buy at that price has expired, but you could still make an offer for the laptops – it’s just the price may have gone up (or down).
For example, if the ACME company offered their employees the option to buy a stock at a price of €20 per share (discounted from the open market price of €25) within an agreed period, and then hold onto those shares for a period of time (usually 3 – 5 years) that employee will be able to sell those shares at the end of the timeframe.
Because they got that initial discount, they are relatively protected against the ups and downs of the stock market and will also be able to take advantage of tax breaks in many countries. In other words, it’s a relatively safe way to invest in the stock market and your company’s future.
As you could imagine, there are all sorts of branches, deviations, derivatives and paths you can take with stock options – every industry needs its own language after all – but, for now, just remember the apples.
Benefits of Stock Options to Employers
Stock options are a cost-effective way for companies to make employment packages more attractive to top talent. They increase staff retention and employee engagement by giving those employees a sense of ownership over the company.
A practical financial benefit is that many jurisdictions will allow companies to offset the cost of setting up an employee ownership plan via a tax break.
Benefits of Stock Options to Employees
Stock options are the most traditional way to reward employees through equity, and come with significant tax benefits for participants
Stock options are a cost-effective way for employees to be rewarded for their work too. From their side, they will often benefit from a discount on the ordinary share price, pay less tax than they would be compared to regular income tax, and build up a more diverse and healthy financial portfolio.
Added to that, in most cases company stock options allow employees to invest without paying brokers fees.
Through stock options, employees truly do reap the rewards when the business does well.
Stock Appreciation Rights (SARs) vs Stock Options – Compared
There are lots of similarities between SARS and Stock Options, so let’s look at them first:
- Both SARs and Stock Options are granted at a set price
- They both will generally have a vesting period (how long you hold onto them) and an expiration date
- Both can be awarded in the form of shares (although it’s more common with SARs to be awarded via a cash bonus)
There are significant differences, however:
- Stock options will generally require the employee to either buy shares at a fixed price or, in the case of a SAYE scheme (or similar), employees will invest part of their regular income towards stock options.
- Stock options are often given at a discounted price by the employer.
- With stock options, you assume the full value of the shares. With SARs, your reward is based on any increases in the value of the shares.
Stock Appreciation Rights (SARs) vs Stock Options – Which is Best for You?
You probably won’t be too surprised when the answer to the question, ‘which is best for you?’, is ‘it depends’.
The reason why these two similar, but different, things came into being is to suit different types of needs. SARs are more flexible when it comes to designing an employee share plan, but much more subject to the whims of the stock market. They allow companies to keep their stock undiluted but also risk not delivering on promised rewards (no matter how carefully the risks are explained).
There’s not much doubt that stock options are the more popular of the two. Why? Tradition is one answer – they’ve been around longer – but also because they are inherently more predictable.
If you’re trying to decide between SARs and Stock Options for your next incentive plan, or want to learn more about how equity compensation and employee ownership can help your business, click here or the button below.