Wondering about SARS and why would an ESOP want them? This question often comes up when a company goes 100% ESOP. Prior to the ESOP transaction, ownership had a direct incentive to increase the share price. After the ESOP transaction, everyone is part of the ESOP and although management will still benefit from an increase in share price, the amount is not as significant and it’s a long-term plan.
This is where SARS (stock appreciation rights) come into play. These are direct incentives for key management linking reward to performance. Many trustees of an ESOP want these in place for management and many in management like them because it allows the ESOP to attract key talent that want incentive compensation.
Successful cases involve multiple rolling tranches of shares. Three to five-year batches allow for a constant carrot on a string, but also allow employees near term benefits that are realizable.
SARS are also granted to former owners who have subordinated debt from the company. In these cases, the SARS provide security interest in the company, protection in value if the ESOP sells out in short order, and additional comp that is only paid when everyone wins (the share price increases).
SARS are paid out in cash, not stock and are taxable to the recipient when paid. GAAP accounting has you record any potential liability after the updated share price is approved for the effective year-end. Contact us if you have ESOP related questions.