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.

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.

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