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- EQUITY COMPENSATION: IN THE NEWS & IN YOUR LIFE
- request for more details
- Less Common Types of Equity — The Holloway Guide to Equity Compensation
Your employer makes most of the decisions when it comes to the structure of the compensation. I hope you found this series informative and helpful. As always, I would love to hear about your specific issues or questions you have with equity compensation. Feel free to contact me at the links below. Search for: x. What are SARs? This will have your important time frames such as the vesting period, exercise dates and expiration dates, as well as how the grant price and exercise price are calculated.
Think about your entire situation: SARs can play an important role in helping you achieve your financial goals, but you have to think about what role exercising your SARs will have on your overall plan and, especially, your taxes. This is a good time to seek the help an independent third-party, such as a tax planner, accountant or financial planner. If they make the election, they are taxed at ordinary income tax rates on the "bargain element" of the award at the time of grant.
EQUITY COMPENSATION: IN THE NEWS & IN YOUR LIFE
If the shares were simply granted to the employee, then the bargain element is their full value. If some consideration is paid, then the tax is based on the difference between what is paid and the fair market value at the time of the grant. If full price is paid, there is no tax. Any future change in the value of the shares between the filing and the sale is then taxed as capital gain or loss, not ordinary income.
An employee who does not make an 83 b election must pay ordinary income taxes on the difference between the amount paid for the shares and their fair market value when the restrictions lapse. Subsequent changes in value are capital gains or losses. Recipients of RSUs are not allowed to make Section 83 b elections. The employer gets a tax deduction only for amounts on which employees must pay income taxes, regardless of whether a Section 83 b election is made.
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A Section 83 b election carries some risk. If the employee makes the election and pays tax, but the restrictions never lapse, the employee does not get the taxes paid refunded, nor does the employee get the shares. Restricted stock accounting parallels option accounting in most respects. If the only restriction is time-based vesting, companies account for restricted stock by first determining the total compensation cost at the time the award is made. However, no option pricing model is used.
If the employee buys the shares at fair value, no charge is recorded; if there is a discount, that counts as a cost. The cost is then amortized over the period of vesting until the restrictions lapse. Because the accounting is based on the initial cost, companies with low share prices will find that a vesting requirement for the award means their accounting expense will be very low. If vesting is contingent on performance, then the company estimates when the performance goal is likely to be achieved and recognizes the expense over the expected vesting period.
If the performance condition is not based on stock price movements, the amount recognized is adjusted for awards that are not expected to vest or that never do vest; if it is based on stock price movements, it is not adjusted to reflect awards that aren't expected to or don't vest.
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- Stock Appreciation Rights and Phantom Stock Plans.
- 2. Exercise Still Important.
- What is in a Share Appreciation Rights Plan?.
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- Stock Options!
Stock appreciation rights SARs and phantom stock are very similar concepts. Both essentially are bonus plans that grant not stock but rather the right to receive an award based on the value of the company's stock, hence the terms "appreciation rights" and "phantom. Phantom stock provides a cash or stock bonus based on the value of a stated number of shares, to be paid out at the end of a specified period of time.
SARs may not have a specific settlement date; like options, the employees may have flexibility in when to choose to exercise the SAR. Phantom stock may offer dividend equivalent payments; SARs would not. When the payout is made, the value of the award is taxed as ordinary income to the employee and is deductible to the employer.
Some phantom plans condition the receipt of the award on meeting certain objectives, such as sales, profits, or other targets. These plans often refer to their phantom stock as "performance units. Careful plan structuring can avoid this problem. Because SARs and phantom plans are essentially cash bonuses, companies need to figure out how to pay for them.
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Even if awards are paid out in shares, employees will want to sell the shares, at least in sufficient amounts to pay their taxes. Does the company just make a promise to pay, or does it really put aside the funds? If the award is paid in stock, is there a market for the stock? If it is only a promise, will employees believe the benefit is as phantom as the stock?
If it is in real funds set aside for this purpose, the company will be putting after-tax dollars aside and not in the business. Many small, growth-oriented companies cannot afford to do this. The fund can also be subject to excess accumulated earnings tax. On the other hand, if employees are given shares, the shares can be paid for by capital markets if the company goes public or by acquirers if the company is sold. Phantom stock and cash-settled SARs are subject to liability accounting, meaning the accounting costs associated with them are not settled until they pay out or expire.
For cash-settled SARs, the compensation expense for awards is estimated each quarter using an option-pricing model then trued-up when the SAR is settled; for phantom stock, the underlying value is calculated each quarter and trued-up through the final settlement date. Phantom stock is treated in the same way as deferred cash compensation.
In contrast, if a SAR is settled in stock, then the accounting is the same as for an option. The company must record the fair value of the award at grant and recognize expense ratably over the expected service period. If the award is performance-vested, the company must estimate how long it will take to meet the goal. If the performance measurement is tied to the company's stock price, it must use an option-pricing model to determine when and if the goal will be met.
Stock Appreciation Rights is a scheme under which the participants, being directors, officers or employees of the company, are entitled to receive cash on account of appreciation in stock prices of the company, subject to fulfilment of certain vesting conditions.
SARs are frequently awarded to employees according to a vesting schedule that is tied to performance goals set by the company. After the fulfilment of such goals, an exercise period is allocated within which the participants can claim the cash allocable toward their SARs. The cash to be paid is calculated on the basis of the Intrinsic value of the SARs, being the difference between the grant price and the fair market price of the shares as on the exercise date.
Participants also receive the benefit of not having to spend cash to buy stock options. They further benefit from the flexibility of SARs in that they can choose when to exercise their rights at any point between the time it vests and until the time it expires. The only logical case when a participant may not exercise his SAR is if the net gain is nil or negative. Grant Price: The cash bonus is paid based on how much the stock has increased over the grant price.
The grant price is usually the fair market value on the date the appreciation rights were granted. Vesting Period: It represents the period during which the vesting conditions are to be fulfilled, and it starts from the grant date. It starts after the vesting period ends, and runs until the expiry date. Expiry date: This is the date when the scheme ends. Beyond this period, no SARs can be exercised by the participants.
Less Common Types of Equity — The Holloway Guide to Equity Compensation
The exercise period will begin once the vesting period ends, and will last for 3 months, during which the employee can exercise his right to receive cash. Assuming that the vesting conditions are fulfilled, on the exercise date if the FMV is Rs. Legal concerns, excess compliance requirements, unwillingness to issue additional shares or shift partial control of the company can cause companies to use an alternative form of compensation that does not require the issuance of actual stock shares.
The first issue is figuring out how many SARs the company plans to give out and identifying the participants of the scheme. Second, the equity of the company must be valued in a defensible, careful way. Finally, availability of funds to finance the SARs during the exercise period must be managed. Identifying the participants to whom the SAR scheme will be offered, total number of SARs to be offered, and the ratio in which they will be offered to the individual participants.
Establishing performance goals to be achieved by the participants as vesting conditions and setting up objective parameters or performance measurement tools to evaluate them.