Employee equity incentive plans are very useful tools for start-ups and even SMEs to reward, align and retain employees. Apart from the popular and more widely known employees share option scheme (ESOS), share appreciation rights (SARs) are another form of ‘equity-linked’ incentives to motivate employees towards increasing the overall value of the organization or to steer towards the goal of public listing.
For companies that do not want to give up equity which dilutes existing shareholdings, SARs do not result in the grant of any actual shares of the company, but instead, take the form of a cash bonus payment to the employees upon exercise. To some employees, receiving cash outright based on the company’s share value may be more attractive than receiving and keeping shares.
Below are some things you need to know before introducing a SARs plan for your employees.
- The employee will receive a cash payment (or shares) equivalent to the value of appreciation of shares
The company offers its employees the right, at some specified future time, to receive a cash award equal to the appreciation in value, tied to a certain number of the company’s shares. Thus, SARs provides employees with the economicbenefits of share ownership only, without effecting any actual transfer or issuance of shares. This also means that the employees will not have any voting rights, dividend entitlement, information rights or other rights or obligations attributable to a shareholder.
The cash value of the share appreciation is the difference between the value of the company’s underlying share price at the date of offer/grant and the company’s share price on the date the SARs are vested. Depending on the by-laws of the SARs Plan, the employee may receive shares, cash, or a combination of both.
For clarity, let’s understand the concept with an example-
John was offered SARs by his employer, ABC Ltd on 1.6.2018, where he would be able to obtain a sum equivalent to the appreciation in value of 20,000 ordinary shares when the SARs are vested. The shares are valued at USD 2.00 each at the time of offer. The vesting period is 2 years from the date of offer and the SARs will expire 1 year after the SARs are vested.
The SARs are vested on 2.6.2020. On the same day, John elects to exercise the SARs in all 20,000 shares. The shares are valued at USD 5.00 per share on 2.6.2020., Thomas will receive a cash benefit of USD 60,000 = 20,000 shares x USD 3.00 (USD 5.00- USD 2.00).
- Similar to ESOS, the share appreciation rights have a vesting period and may expire
Vesting of the SARs can be either time based or performance based, or both. If the vesting is purely time-based, the SARs will be vested after the employee has completed the length of service as provided in the award letter.
If the SARs are vested and the employee does not exercise them within the stipulated time frame, the SARs will expire and the employee is no longer entitled to any benefit. Using the above example, if John doesn’t exercise the vested SARs within 1 year from 2.6.2020, the SARs will expire.
- The benefit an employee receives from SARs is taxable
The cash benefit that an employee receives from SARs is considered a ‘prequisite’ received in respect of exercising the employment and therefore constitutes employment income. Thus, just like an ESOS, the cash benefits received will be subject to income tax in the hands of the employee. The employee will need to account for income tax on such a benefit in the year of assessment the SARs are vested/paid out. The company should therefore also ensure that the employee’s Form EA includes the amount that the employee receives from SARs each year.
Further, the cash benefits could be subject to Employees Provident Fund (EPF) as it results in the employee receiving “remuneration in money”.
- The shares of an unlisted company is valued based on the company’s Net Asset Value
Based on the public ruling issued by the Inland Revenue Board, as there is no publicly available market value for shares offered by companies that are not listed on any stock exchange, the market value per share is ascertained by dividing the net asset value of the company by the number of ordinary shares. Net asset value of the company is calculated as total assets less total liabilities, based on the company’s audited accounts.
The above formula may not extend to instances where the company has issued different classes of shares (e.g preference shares and ordinary shares), especially when preference shares have priority in distribution of the company’s assets. In such instances, the calculation above may not accurately reflect the share value based on the rights attached and may require a more in depth study of the various share rights before computation.
- Employees do not have to pay or purchase the SARs
Under an ESOS, an exercise price or strike price is usually set by the company upon the grant of an option, which means that the employee will need to fork out their own money to exercise their vested options. In contrast, the employees can typically receive the cash benefit (the share appreciation value) under the vested SARs without paying for the cost of the shares.
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