Looking for the simplest and fastest way to let an employee participate financially in the growth of a company in the Netherlands (and any other place in Europe)? Then you arrive at Stock Appreciation Rights (SARs). In fact, this is nothing more than promising an employee that he or she will get money when the value of the company’s stock rises. Often the promise is that someone will get as much money as the share’s jump in value. Unfortunately, in practice this form of employee participation mainly works to the advantage of the employer.
At start-ups and scale-ups, the value jump is often only measured when there is an ‘exit’ moment. This means that the employee receives compensation for the increase in the value of the share, when the company is sold. In other cases (often with management), the same jump in value is measured annually and the payment is also made annually.
Suppose an employee joins scale-up X on January 1, 2016. At that time, the company has 1,000 shares of 10 euros each (so the company is worth 10,000 euros). With the employment contract, the employee receives 20 SARs. This means that the employee is rewarded for the increase in value of 40 of the 1,000 shares (4% of the share capital). This applies when the business is sold. If the company is sold on December 31, 2019 for 1,000 euros per share (total sales value is therefore 1 million euros), the employee can expect a payout of 40 x 990 euros (the increase in value per share). This is equal to 39,600 euros.
Advantages of SARs
SARs are – just like the economic ownership rights and depositary receipts – regulated by a private contract. This has the advantage that you do not have to go to the notary to set up or change the participation. Furthermore, the SARs form a much looser connection than the Economic Property Rights or depositary receipts for shares. SARs (according to HR Kiosk) are actually nothing more than a claim to a payment in money, the amount of which depends on the value development of the underlying share. Now that 39,600 euros from the example is of course a nice amount if:
- this would be paid out in full;
- the employee actually owns it; and
- an employee can always reap the benefits of this.
Unfortunately, it does not work like this in practice! The amount is not paid out in full due to high taxes. The employee owns nothing at all. Moreover, the employee can only reap the benefits if he or she has completed the journey. For the employer, SARs do offer a number of advantages, which is precisely why employers often choose this option.
1. It is a ‘bonus reward’, for which the employee pays all costs
The payout of 39,600 quoted in the calculation example is considered a bonus by the tax authorities. The result of this is that in general a 52% tax is levied. This tax is the responsibility of the employee. Ultimately, a maximum of 19,008 euros remains of this amount. The cash payment is, on the other hand, tax deductible from the employer’s profit, without further consequences for any fiscal unity. For this reason, SAR schemes are generally more tax-efficient for the employer than (for example) stock option schemes. In my opinion, this is not an equal distribution of burdens and benefits and the SARs as such do not qualify as a form of actual employee participation.
2. The employee is simply NOT a co-owner
The legal relationship between the employer and the employee at SARs is governed by an agreement. As a result, a lot of elements that are present in co-ownership are excluded from this arrangement. An advantage for the employer is that no rights in the company or obligations are attached to SARs. For example, the employees who have been awarded SARs have no voting rights. The agreement determines separately whether the following matters are included when determining the amount of the payment in cash:
- dividend, which is paid on the underlying shares during the term; or
- a capital distribution that takes place during that period.
3. Employee cannot leave in the meantime
SARs are awarded to bind and motivate employees. The SARs can therefore generally no longer be exercised if the employment relationship is terminated. Also, the SARs generally cannot be transferred.
When SARs do work
Investopedia has a nice article about the use of SARs in the USA. This also explains – in my view well – when SARs do work for both parties. This is the case when SARs are set up alongside a shareholding plan to enable the employee to pay for the shares through the SARs scheme. In this case, a lot of tax still has to be paid on the SARs scheme, but the ‘little man’ can also get the chance to participate.
Precise documentation pays off!
If you do decide to choose for a SARs scheme, keep the following in mind: although the implementation of SARs is relatively simple, the conditions must be formulated carefully. SARs are not laid down in law and there are no fixed rights and obligations. This all has to be arranged separately. The following applies to both the employer and the employee: keep a close eye on this to avoid having to pay wage tax when the SARs are awarded. Also prevent that agreements are ultimately too long-winded, so that the finish line can never be reached. Share Council offers good templates for this. In addition, we are happy to inform you about very good alternatives, such as depositary receipts and economic ownership of shares.
Why should you choose Share Council?
Share Council’s participation platform ensures that, after setting up the structure and selecting the contracts, there is no need to think about administration. Everything is arranged and maintained for you in the background. We want to make every employee a hero and move closer to our goal of reducing capital inequality in society.
We have a wide variety of payment plans available. It doesn’t matter what your budget is or how much time you have to spend on participation, we have a plan for you! Want to find out more about our plans (mission) or create an account? Contact us. We are always open for a conversation.
Quintus Willemse – founder Share Council