Keeping key employees engaged and incentivizing them to remain with your company can feel like a herculean task. The job market is brutal and getting talent is hard enough, when you find the ones who are key to running your business it is crucial to put strategies in place to incentivize them to stay. In this blog, we discuss two “Golden Handcuff” strategies that are important to know about.
Stock appreciation rights (SARs) and phantom stock are both types of equity-based compensation plans that are commonly used by companies to incentivize and retain key employees. However, there are some key differences between these two types of plans that are important to understand.
Stock Appreciation Rights (SARs)
Stock appreciation rights (SARs) are a type of equity-based compensation plan that give employees the right to receive cash or stock equal to the increase in the value of the company’s stock over a specified period of time.
SARs are typically granted to employees as part of their overall compensation package and are designed to align the interests of the employee with those of the company’s shareholders. When the company’s stock price increases, the value of the SARs also increases, providing a financial incentive for the employee to work toward increasing the company’s share price.
One key advantage of SARs is that they can be structured in a way that allows employees to benefit from the increase in the company’s stock price without having to purchase any stock. This can be particularly attractive for employees who may not have the financial resources to invest in the company’s stock themselves.
Additionally, this allows them to benefit from the upside from the current valuation, not from the ground floor. If you have a key person who joined you two years ago and you started your company 10 years ago, why should they benefit from the equity you built? In my view, that would be a really nice Christmas gift. SARs incentivizes them to produce and benefit from their work, not on the backs of others. I like this approach as it is pure meritocracy.
Phantom stock, on the other hand, is a type of equity-based compensation plan that does not involve the actual ownership of stock. Instead, phantom stock represents a promise by the company to pay the employee a certain amount of money at a specified time, based on the performance of the company’s stock.
Like SARs, phantom stock plans are designed to incentivize and retain key employees by tying their compensation to the performance of the company’s stock. However, since phantom stock does not involve actual ownership of stock, it can be a more flexible and cost-effective way for companies to provide equity-based compensation to employees.
Phantom Stocks Advantages
One advantage of phantom stock plans is that they can be structured in a way that allows the company to retain control over the actual ownership of its stock. This can be particularly important for privately held companies that may not want to dilute their ownership structure by issuing actual shares of stock to employees.
Another advantage of phantom stock plans is that they can be structured in a way that allows employees to receive cash payments rather than stock, which can be more attractive to employees who may not want to take on the risk associated with owning stock.
The key difference between SARs and phantom stock is that SARs provide employees with the right to receive actual stock or cash equal to the increase in the value of the company’s stock, while phantom stock represents a promise by the company to pay the employee a certain amount of money based on the performance of the company’s stock.
Additionally, SARs are typically more closely tied to the company’s stock price, while phantom stock plans can be structured to provide more flexibility in terms of the timing and amount of payouts.
While both SARs and phantom stock are equity-based compensation plans that are designed to incentivize and retain key employees, they differ in their structure and the way they provide value to employees.
Companies should carefully consider their goals and objectives when choosing between these two types of plans, and work with their legal and wealth advisors to develop a compensation strategy that is both effective and compliant with relevant regulations.
As I have mentioned in previous blogs, having a Wealth Advisor who specializes in Exit Planning is crucial as we have a network of professional advisors who in my opinion are best in class who help advise on these types of planning strategies and implement them.