As an incentive tool, employee participation offers employees the opportunity to participate in the company and reward them for their contributions.
Basically, employee participation plans can take two different forms:
- Share based;
- Cash based,
The best known concepts of share based employee participations are depository receipts of shares, options or convertible loans. Forms of cash based employee participation are for example profit sharing, phantom stocks and - the alternative which recently is getting again more attention - share appreciation rights (SARs).
Introduction SARs
SARs are contractual rights entitling the employee to a payment in cash equal to the appreciation of the shares in the company over a certain period of time. SARs are characterized by:
- receiving the SARs gratuitously
- appreciation only
- linked to employee-relationship
- non-assignable
- no voting rights
- conditionally entitlement
- income tax due moment when the SARs becomes unconditional
From a tax perspective we note that companies consider to opt for SARs because payments are regarded deductible for corporate income tax purposes (up to a certain maximum amount) while all tax and social security premiums will be for the account of the employee.
Please note that the tax implications of SARs should be verified by the tax advisor of the company.
Normally, the contractual rights of the SARs are determined in an individual SARs agreement between the company and the employee or in an share appreciation arrangement whereby each individual employee becomes a participant via a participation agreement.
In the SARs agreement or arrangement a fixed grant price is being set as of the moment the SAR is being granted by the company to the employee. The difference between the grant price and market value of the company’s shares over time is the amount payable to the employee. Most of the times the market value will be determined as per the moment a so called vesting event occurs, for example an acquisition of the (majority of the) shares or a financing round.
An example
On January 2021 (the so called grant date), a scale-up company in the medical technology grants 100 SARs to a member of the management team. Each SAR correspondents with one ordinary share of the company. The price per share as at the grant date is set at EUR 50,00 (the so called grant price).
On 1 January 2025 the scale-up is being acquired by an big international market player (which is a so called vesting event) based on a share price of € 150,00 per share. The vesting event entitles the employee to payment of 100 SARS multiplied by EUR 100,00 per share= EUR 10.000,00.
Of course there are certain points to take into account when a company is considering this form of cash based employee participation, such as:
- clear agreement about the appreciation, payment obligations and vesting events;
- options if there is no available cash when the SARs are being exercised;
- scenario’s if the employee leaves the company and determine whether he/she is still entitled to the SARs;
- taking into account the rules of a good employer within the meaning of article 7:655 Dutch Civil Code;
- the obligation to sufficiently inform the employee about the SARs, consequences and risks (if any) as a good employer.
Legal proceedings
In various occasions, the aforementioned issues where part of discussions between the employer and the employee.
In one situation the Dutch court had to judge whether a vesting event had occurred[1], while in another case the Dutch Court had to judge on the arrangements on the appreciation of the SARs and the calculation of the payment amount.[2]
Also interesting was a judgement before the court of appeal in Amsterdam. In this proceeding SARs were granted by the company to the employee which he could exercise when an acquisition occurred. The employee stated that at the beginning of his employment the impression was given that a take-over of the company would occur which would trigger a good upside for the SARs, however the owner/shareholder eventually did not sell the company. The employee claimed damages in this proceeding because according to him the sale of the company was an absolute certainty which was used to persuade him to join the company. The court of appeal rejected this claim.[3]
[1] Court Utrecht, 18 May 2011, (ECLI:NL:RBUTR:2011:BQ6333).
[2] Court The Hague 7 November 2016 (ECLI:NLRBDHA:2016:14226) and the Court of appeal Arnhem, 22 January 2013 (LNJ BZ0379). The court had to render a judgment on the question whether the company in question could rightfully deduct a loan in order to finance acquisitions from the EBIT (on the basis of which (inter alia) the payment amount was based). The answer was yes, resulting in an appreciation of the shares of nil and no payment obligation towards the relevant employee.
[3] ECLI:NL:GHAMS:2014:517.