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Phantom Vs. RSU Vs. SARs: Which is the Most Ideal Plan for You?

  • Written Written by Shubhika Sundriyal 28 March 2024 | 4 min read
  • Editor's Note :

    So, you’ve decided to implement a contemporary equity compensation strategy for your employee compensation plan is a commendable decision. However, a challenge lies ahead – choosing the right one. We understand that it can be tricky. Don’t worry. This blog will guide you effortlessly through Phantom Vs. RSU Vs. SARs. Continue reading to gain a clear understanding!

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In the ever-evolving landscape of employee compensation, the options are not limited to just a fixed monthly salary. As HR or finance professionals, it's crucial to consider what sets your organization apart in attracting and retaining talent. Merely recruiting and training employees, only to witness them leave within a year, is a situation best avoided.

The solution is straightforward. Adopt from contemporary trends in compensation—Phantom Stocks, Restricted Stock Units, and Stock Appreciation Rights. These innovative strategies are currently dominating the compensation arena and have been widely adopted by your industry peers. They're exactly what potential employees seek in their quest for the next career move.

So, without further ado, let’s begin understanding these innovative compensation plans!

Definitions at a glance

Phantom Stocks: Phantom stocks are a form of employee incentive where employees receive hypothetical/virtual shares, reflecting actual stock value. Unlike actual equity, employees don't own tangible shares but receive cash or equivalent value upon certain conditions.

RSUs (Restricted Stock Units): RSUs are a form of employee compensation where a company grants its employees a certain number of shares, typically linked to performance milestones or tenure. Unlike traditional stock options, employees are not required to buy company stock upon vesting. Instead, they seamlessly acquire the shares once the predetermined vesting conditions are fulfilled.

SARs (Stock Appreciation Rights): SARs offer employees the right to receive cash or stock equal to the appreciation in company stock value over a predetermined exercise price, fostering employee motivation without actual stock ownership.

Importance of Employee Stock Ownership

Phantom Stocks

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How does it work?

Imagine an employee is granted phantom stocks equivalent to 100 shares. If the company's stock price rises, the employee would receive the appreciation value in cash. For instance, if the stock price increases by $50 per share, the employee gains $5,000.

Advantages for Employees:

Phantom stock plans motivate employees as they can benefit from the company's success without owning actual shares. The cash payout provides a tangible reward, fostering loyalty and aligning employee interests with company performance.

Advantages for Employers:

Employers benefit from increased employee engagement and performance. Phantom stock plans are a non-dilutive way to share success, as employees don't acquire real equity. It also helps attract and retain talent without altering the company's ownership structure.

Potential Disadvantages:

While phantom stock plans offer flexibility, they may create financial obligations for employers, especially during economic downturns. Additionally, employees might not fully grasp the concept, leading to misunderstandings about their potential benefits. Careful communication and structuring are crucial to mitigate these challenges.

When to choose?

Phantom stocks are a non-physical form of equity compensation that tracks the value of company shares. They are ideal for companies seeking to motivate employees without actual stock ownership transfer. Phantom stocks provide a cash equivalent at a predetermined date, aligning employee incentives with company performance while avoiding actual stock issuance.

RSUs (Restricted Stock Units)

How does it work?

Let's say an employee is granted 100 RSUs. Over a four-year vesting period, 25 RSUs vest annually. If the employee stays with the company for the full term, they receive 25 shares each year. If they leave early, the unvested RSUs are forfeited. Upon vesting, employees often receive the company's actual stock.

Advantage for employees:

Unlike stock options, RSUs guarantee value, as they convert into stock regardless of the stock's current market price. Also, RSUs often provide a financial cushion, allowing employees to benefit from the company's success without upfront costs.

Advantage for employers:

RSUs are a powerful retention tool, encouraging long-term commitment. As employees wait for vesting, it ensures a vested interest in the company's sustained success. RSUs also link compensation directly to stock value, promoting a shared goal of increasing shareholder value and company performance.

Potential Disadvantages:

One drawback for employees is the lack of control over the timing of taxation for employees. RSUs are taxed as ordinary income upon vesting, potentially leading to higher tax liabilities. For employers, the cost of issuing RSUs and the potential dilution of existing shareholders' stakes are considerations. Also, if the stock price drops, RSUs may lose value for employees, affecting morale.

When to choose?

RSUs grant employees a stake in the company's stock after a fixed vesting period. Companies often choose RSUs to retain talent and encourage long-term commitment. RSUs provide a direct ownership interest and can be beneficial when wanting employees to share in the company's success over time, as the value is tied to the stock's performance.

SARs (Stock Appreciation Rights)

How does it work?

Imagine an employee named Ashley, who is granted Stock Appreciation Rights (SARs) for 100 shares in her company at a strike price of $50 each. SARs typically have a vesting period, during which Ashley must wait before she can exercise them.

Now, let's say the stock price of the company rises to $60 per share during the SARs' vesting period. At this point, Ashley decides to exercise her SARs.

If Ashley opts for a cash settlement, she would receive the appreciation in the value of the shares, which is $10 per share ($60 - $50). Multiplying this appreciation by the number of shares covered by her SARs (100 shares x $10 appreciation per share), she would receive a total cash settlement of $1,000.

Alternatively, Ashley could choose a stock settlement. In this case, instead of receiving cash, she would receive actual shares valued at $1,000 (100 shares x $10 appreciation per share). This means she would be granted additional shares in the company equivalent to the appreciation in the value of her SARs.

So, whether she opts for cash settlement or stock settlement, Ashley benefits from the appreciation in the company's stock price during the SARs' vesting period.

Cash Settlement vs. Stock Settlement

SARs offer flexibility in settlement methods. Cash settlement involves receiving the appreciation amount in cash, while stock settlement provides employees with company shares equivalent to the appreciated value. The choice between cash and stock settlement depends on the employee's preferences and the company's policies.

Advantages for Employees:

Employees benefit from SARs as they receive the financial gain from stock appreciation without investing their own money. This allows them to profit from the company's success without the risks associated with traditional stock ownership.

Advantages for Employers:

Employers find SARs attractive as they incentivize employees to contribute to the company's growth. SARs align employee interests with shareholder interests, fostering a sense of ownership and commitment without diluting existing shareholders' stakes.

Potential Disadvantages

One potential drawback is the tax implications for employees upon SAR exercise. The appreciation is usually taxed as ordinary income. Also, if the company's stock value declines, SARs may lose their value, leading to reduced employee motivation.

When to choose?

SARs provide employees with the right to appreciation in the company's stock value without the need for actual ownership. This allows employees to benefit from stock value increases. SARs are suitable when companies wish to link compensation to stock performance while avoiding the complexities of actual stock ownership.

Key Differences Among Phantom Stocks, RSUs, and SARs

Key Factors
Phantom Stocks
RSUs
SARs
Ownership Rights
No actual stock ownership
Actual stock ownership upon vesting
No actual stock ownership
Dividend Payments
No dividends
Receives dividends when RSUs vest
No dividends
Vesting Period
Typically has a vesting period with conditions
Has a vesting schedule over time
Dependent on a vesting period with conditions
Payout Mechanism
Cash upon triggering event (e.g., sale)
Company stock upon vesting
Cash upon triggering event
Tax Implications
Taxed as ordinary income upon payout
Taxed as ordinary income upon vesting
Taxed as ordinary income upon payout
Conversion to Shares
Doesn't convert to actual shares
Converts to actual shares upon vesting
May result in cash or stock settlement
Liquidity for Holder
Cash settlement provides immediate liquidity
RSUs may be sold after vesting, providing liquidity
Cash settlement provides immediate liquidity

Choosing the Right Equity Incentive Plan

By now, you understand that phantom stocks imitate stock ownership, while RSUs grant tangible shares. SARs, however, provide employees with the financial benefit of stock appreciation without actual stock ownership.

Restricted Stock Units (RSUs) are widely prevalent in the private sector, with sought-after companies such as Amazon, Uber, Apple, and Microsoft frequently incorporating them into their employee compensation packages. In addition to traditional RSUs, some companies, such as DLF, Birla Sunlife, and Bajaj Allianz, opt for innovative approaches like phantom stock options. Notably, Apollo Tubes stands out for its practice of granting stock appreciation rights to its employees, contributing to the diverse landscape of employee incentive programs in the corporate sector.

Choosing the right equity incentive plan for your organization involves considering various factors. These include the extent of equity dilution you're comfortable with, the perks you're willing to offer employees, and the projected profits over a specific period. To navigate this decision-making process, outline your unique needs and identify plans that align with your long-term goals without hindering progress.

Once you've pinpointed the ideal equity compensation plan, streamline your implementation process by leveraging user-friendly platforms like Vega Equity. Simplify your day-to-day equity and cap table management effortlessly, allowing you to focus on driving your organization's success.

About Vega Equity

Vega Equity offers companies an effective, intuitive, and paperless platform for managing equity. It provides accurate cap table management, customized user experiences, and precise information. Additionally, it assists in measuring KPIs, analyzing data, and tracking performance towards goals.

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