Phantom equity for employees, management and advisers without issuing shares
Category: InsightsPhantom equity for employees, management and advisers without issuing shares
Stock Appreciation Rights, or SARs, are a contractual way to give employees, management, advisers or other key contributors economic upside without issuing actual shares.
Instead of becoming a shareholder, the participant receives a right to a cash payment linked to the increase in value of the company. If the value of the company increases between the grant date and the exercise or exit date, the participant may receive a payment based on that increase.
For Dutch startups, scale-ups and growth companies, SARs can be useful when the company wants to reward and retain talent, but does not want to create new shareholders, voting rights, notarial share transfers or a more complicated cap table. For investors, SARs can be attractive because they align incentives without immediately changing ownership or governance.
SARs are not a shortcut. They should be carefully documented. The grant agreement must explain who participates, how value is measured, when the SARs vest, when they can be exercised, what happens on a leaver event and how payment is made.
This article connects to Dutch Venture Capital Insights, Venture Capital Lawyer in the Netherlands, Cap Table Adjustments in Dutch Startups and Scale-ups and Management Participation in Dutch Private Equity Deals.
How SARs work
A SAR gives the participant a contractual claim on value appreciation. The participant does not receive shares and usually does not receive voting rights, meeting rights or shareholder information rights.
A simple example:
A participant receives SARs linked to 1% of the company’s equity value. At grant, the company is valued at EUR 5 million. At exit, the company is valued at EUR 20 million. The value increase is EUR 15 million. If the SARs are fully vested and the agreement uses this simple formula, the participant may receive 1% of the value increase: EUR 150,000.
In practice, the calculation is often more detailed. The agreement should define the base value, exit value, fully diluted basis, treatment of debt, transaction costs, preference shares, liquidation preferences, option pools, anti-dilution rights and other instruments that may affect the economic outcome.
That is why SARs should not be described only as “1% phantom equity”. The payout formula matters.
Why companies use SARs
SARs are often used when a company wants to create equity-like incentives without issuing real equity.
For founders and boards, the main advantage is control. Participants receive economic upside, but do not become shareholders. They do not vote in the general meeting and do not need to be included in the shareholder register.
For investors, SARs can help professionalize the incentive structure without disturbing the investment round. A SAR plan can sit alongside the shareholders’ agreement and cap table, provided the economic impact is understood and disclosed.
For participants, SARs can be attractive because they provide upside if the company grows in value. They are simpler to understand than some share class structures and may avoid the formalities connected to issuing or transferring shares.
SARs are especially useful for key employees, senior managers, commercial hires, technical talent, advisers or consultants who should share in value creation but do not need to become shareholders.
SARs compared with shares, options and certificates
SARs are not the only way to create incentive participation.
Actual shares give the participant direct ownership. That may be attractive for senior founders or management, but it also creates shareholder rights, transfer restrictions, possible voting or meeting rights and Dutch notarial implementation.
Options give the participant the right to acquire shares later. They can be useful, but the future issuance or transfer of shares must still be implemented correctly. Options also require careful tax, valuation, vesting and leaver analysis.
Certificates issued through a Dutch STAK can separate economic rights from legal ownership. That structure can work well in some cases, but it requires a foundation, administration conditions and more formal governance.
SARs are different. They are contractual. The participant receives a cash-settled right based on value development. That makes SARs flexible, but also creates a cash-payment obligation for the company when the SARs are exercised or triggered.
Key terms in a SAR plan
A strong SAR plan should address the following points clearly.
The plan should define the participants and the number or percentage of SARs granted. It should explain whether the SARs represent a percentage of equity value, a fixed number of reference shares or another formula.
The valuation mechanism is central. The agreement should specify the grant value, exercise value, valuation method, who determines the value and how disputes are resolved.
Vesting should be clear. SARs may vest over time, on milestones, on an exit or through a combination of these triggers. If the purpose is retention, immediate full vesting will usually not be appropriate.
Leaver provisions are essential. The plan should say what happens if the participant resigns, is dismissed, becomes a good leaver, bad leaver or intermediate leaver, or stops providing services before an exit.
The plan should also define exercise events. SARs may become payable on a sale of the company, IPO, change of control, termination of employment, board-approved liquidity event or another agreed trigger.
Finally, the company should model cash impact. A SAR plan may not dilute shareholders directly, but it can create a substantial cash liability at exit or another liquidity event.
Dutch implementation points
For a Dutch BV, SARs are usually implemented by contract. A notarial deed is generally not required to grant the SARs, because no shares are issued or transferred at that stage.
That does not mean the legal work is light. The SAR plan should be aligned with the articles of association, shareholders’ agreement, investment documentation, existing option arrangements and any investor consent rights. If the plan can create a material payment obligation, board and shareholder approvals may be required under the governance documents.
Tax and payroll treatment should also be reviewed separately. SARs granted to employees or management may have wage tax, social security, valuation and reporting consequences. These points should be coordinated with tax and accounting advisers before the plan is signed.
The key legal point is that SARs should be integrated into the company’s wider incentive and financing structure. They should not be an informal side promise.
Practical conclusion
SARs can be a practical tool for Dutch companies that want to reward and retain talent without issuing shares or expanding the shareholder base.
They are particularly useful where the company wants to preserve a clean cap table, avoid voting rights for participants and create a flexible value-sharing arrangement. But flexibility creates its own risks. The payout formula, vesting, leaver rules, valuation, tax treatment, investor consent and cash impact must be clear.
A well-drafted SAR plan aligns contributors with value creation. A poorly drafted SAR plan creates disputes at exactly the moment when the company is preparing for a financing round, sale or exit.
FAQ
Do SAR participants become shareholders?
No. SAR participants usually receive a contractual cash-settled right. They do not become shareholders and do not receive voting rights or meeting rights.
Do SARs dilute existing shareholders?
Not directly in the same way as shares or options. However, SARs can reduce value available to shareholders because the company may need to make a cash payment on exercise or exit.
Is a Dutch notary required for SARs?
Usually not for the grant of SARs, because no Dutch BV shares are issued or transferred. If the arrangement is changed into actual equity, notarial implementation may become relevant.
When are SARs paid out?
That depends on the agreement. Common triggers include an exit, change of control, IPO, termination event or board-approved liquidity event.
Are SARs suitable for founders?
Usually SARs are more common for employees, management, advisers or consultants. Founders more often hold actual shares, but SAR-style arrangements can sometimes be used in specific incentive or retention structures.
About Dirk de Waard
Dirk de Waard is a Dutch corporate, M&A and venture capital lawyer and partner at Venture Lawyers in Amsterdam. He advises founders, startups, scale-ups, investors and management teams on Dutch venture capital, employee participation, SARs, option plans, shareholders’ agreements, cap table structuring and Dutch BV implementation.
ViottaLaw is Dirk’s personal insights platform. Legal services are provided through Venture Lawyers.
Need to structure a SAR plan?
SARs can be an effective incentive tool, but the plan should be clear on valuation, vesting, leaver treatment, payment triggers, investor consent and tax coordination.
Dirk de Waard advises Dutch startups, scale-ups and investors on SAR plans, employee participation and management incentives. Contact Dirk at dirk.dewaard@viottalaw.com to discuss the right structure before implementing a SAR plan.
