Why Giving Your Employees Phantom Stock Can Boost Your Company

The problem of motivating and retaining key employees without giving away your company’s equity can be solved by the use of a phantom stock plan. Many company owners are hesitant to provide key employees with an actual company ownership interest. Such an ownership interest would likely entitle key employees to notice, inspection, and voting rights. Additionally, these key employees would be able to hold the company responsible for a breach of fiduciary duties. Thus, phantom stock is a great way to share the economic value of your company without the hassle of giving up company stock.

Phantom stock plans are contracts between the company and key employees designed to parallel actual ownership of company stock. Under a phantom stock plan, the company grants a certain amount of stock units to key employees. Each unit equals the value of a current share of the company’s common stock. In the typical phantom stock agreement, the benefit provided to the key employee equals the appreciation in the value of the stock between the date the employee was credited with the phantom stock and the date the benefit is paid. Other phantom stock plans can be based on company sales or profits.

You can implement a vesting schedule for phantom stock so that your key employees receive their phantom stock over time instead of all at once. Payment of the phantom stock benefit usually occurs upon termination of employment as a result of retirement, death, or disability. The benefit can be paid out in installments and in either cash or actual common stock of the company. Generally, benefits are paid in cash because the company does not want to give away ownership of the company.

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When implemented along with other incentive plans, phantom stock can be a useful tool to retain key employees without the hassle of making them shareholders.

Employees and Consultants

14 thoughts on “Why Giving Your Employees Phantom Stock Can Boost Your Company

  1. I am trying to put together a compensation package for my employees. My company is still in its early startup stages and from experience with a couple others I tried to bring on to the company, I am not sure I want to give away equity easily. Phantom stocks sound like a good idea but I am not sure if my employees will buy it? It does motivate them to work hard to grow the company's value, but if they know they have to work for 1-2 years before they can reap the rewards of their efforts, will their motivation last that long?

    Also, during the uncertain early phases (when the team is working to achieve proof-of-concept), it seems that equity providing employees with the right to vote, dividends, winding up…give employees more certainty than phantom stocks?

  2. I am trying to put together a compensation package for my employees. My company is still in its early startup stages and from experience with a couple others I tried to bring on to the company, I am not sure I want to give away equity easily. Phantom stocks sound like a good idea but I am not sure if my employees will buy it? It does motivate them to work hard to grow the company's value, but if they know they have to work for 1-2 years before they can reap the rewards of their efforts, will their motivation last that long?

    Also, during the uncertain early phases (when the team is working to achieve proof-of-concept), it seems that equity providing employees with the right to vote, dividends, winding up…give employees more certainty than phantom stocks?

  3. To answer your first question, I believe what "long-term" motivation means for the employee is shrinking in length. Unfortunately for the business owner, "long-term" for the average employee could simply mean the next pay period.

    As to the second question, giving employees equity (instead of phantom stock) does give them more certainty. But their certainty comes at a potentially steep price for you, especially if you have no previous experience with the employee.

    Each employee will have his or her own tolerance for both the type of incentive and the length of the vesting period. In the least, you can use the somewhat longer vesting period (for phantom stock) to filter out those employees who are likely to jump ship rather than stay around long term.

  4. To answer your first question, I believe what "long-term" motivation means for the employee is shrinking in length. Unfortunately for the business owner, "long-term" for the average employee could simply mean the next pay period.

    As to the second question, giving employees equity (instead of phantom stock) does give them more certainty. But their certainty comes at a potentially steep price for you, especially if you have no previous experience with the employee.

    Each employee will have his or her own tolerance for both the type of incentive and the length of the vesting period. In the least, you can use the somewhat longer vesting period (for phantom stock) to filter out those employees who are likely to jump ship rather than stay around long term.

  5. How does an employee value phantom stock as part of a compensation package? For instance, if phantom stock is offered at year 3, to be "vested" at year 5 (when you start receiving dividends in cash), how do you value that amount in year 3, before it's actually earned?

  6. How does an employee value phantom stock as part of a compensation package? For instance, if phantom stock is offered at year 3, to be "vested" at year 5 (when you start receiving dividends in cash), how do you value that amount in year 3, before it's actually earned?

  7. Amy,

    I think you have to develop your own formula based on the time value of money, vesting schedule, payout triggering event schedule, payout types (cash, stock, etc.). It really becomes a personal valuation but those are the typical considerations.

  8. Assuming funds were set aside in a rabbi trust to defer taxes, is that something that is generally accessable? For instance, I am willing to take on a particular position for a salary lower than I am accustomed to with the belief that it will benefit me greater being included in a phantom stock plan. Would I then be able to remove a portion of the funds set aside to supplement my salary while leaving the remainder to grow?

  9. Assuming funds were set aside in a rabbi trust to defer taxes, is that something that is generally accessable? For instance, I am willing to take on a particular position for a salary lower than I am accustomed to with the belief that it will benefit me greater being included in a phantom stock plan. Would I then be able to remove a portion of the funds set aside to supplement my salary while leaving the remainder to grow?

  10. Cheers Startup Lawer –

    Can anyone recommend additional resources that would be helpful in investigating Phantom Stock applicability for a startup and additional resources for more in depth information about the nitty-gritty details?

    Thanks!

  11. Cheers Startup Lawer –

    Can anyone recommend additional resources that would be helpful in investigating Phantom Stock applicability for a startup and additional resources for more in depth information about the nitty-gritty details?

    Thanks!

  12. Is phantom stock only available to employees, or could it be used where shareholders are not employees. For example in a professional corporation where all professionals are shareholders?

  13. Is phantom stock only available to employees, or could it be used where shareholders are not employees. For example in a professional corporation where all professionals are shareholders?

  14. If an S corporation company has an abundance of employee phantom stock and the offical agreement states that the phantom stock (points)becomes common stock upon a triggering event and one triggering event is when the founders/owners own less than 90% of the voting stock for which the company changed the total number of shares from 1 million to 1,000 stocks and their corporate documents clearly show that the founders/owners have retained less than 10% of the stock. Would this constitute a triggering event for which the stock agreement would allocate the remaining 90% of the stock to the employees and if so can they go back and change any or all information which appears may happen.

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