The Invisible Asset: Understanding the Magic of Phantom Stock

Phantom stock (or shadow stock) is a type of equity compensation that provides employees with the benefit of receiving a share in the potential future success of a company, without actually owning any stock or having any voting rights. It is a form of generally non-vested, deferred compensation that is tied to the performance of the company and can be used as a tool to motivate and retain employees.

With shadow stock, employees receive a payout if certain performance goals are met, usually in the form of cash or actual stock. This allows employees to share in the company’s financial success, providing them with a sense of ownership and incentivizing them to work harder and more efficiently. Most commonly, it is offered by some companies to their senior employees, consultants, board members, or key strategic partners.

Is it actual ownership of a company?

No! Phantom stock gives its owner some financial benefits of owning shares without having actual ownership of company stock. It does this by linking payment benchmarks to the value or distribution associated with actual stock.

How do Owners get paid?

There are several different ways a phantom stock owner can get paid:

• Sale of Company. The most common form of compensation is upon sale of the company. This benchmark allows the Phantom stockholder to get a payout in the same amount, or at least an amount linked to the value of the actual shares of the company.

• Revenue. Some shadow stock is paid out as a revenue share. Whenever the owners of the company take a distribution a phantom stock payment, similar to a bonus, is paid out to the holder of the phantom stock.
• Buy-back Trigger. Some phantom stocks are triggered upon a certain event being hit, usually at a price fixed to actual stock. This method is useful in hitting target goals.

Are there other tools that can be used instead of phantom stock?

Yes, those looking into using this method of compensation should also consider stock options, employee bonuses, nonvoting stock, and other tools to achieve the same or similar purpose as the phantom stock is attempting to achieve.

Does phantom stock vest?

It does not have to vest, but vesting periods can be added to the plan as the employer desires.  

A New Compensation Trend

Phantom stocks, as a tool of compensation, are becoming increasingly prevalent. Many companies are using them as a part of a total compensation package. Much of their use moving into the future will depend on the perceived value by the recipient.

Employees generally like these plans because, there is no need for the participant to purchase phantom stock shares the way regular stockholders must acquire shares from other types of compensation plans. Phantom shares are instead given to employees, with no money changing hands. That’s a big benefit to employees. They can potentially share in the company stock’s profits without having to spend money to do so.

Can I use phantom stock as a method of raising capital?

You really should use phantom stock as a tool for compensation, to help stakeholders maintain skin in the game, and not as a method of raising capital. In other words, you generally would not see a recipient paying to receive phantom stock.

Is it generally a good investment?

No, it is generally not a good investment, because the investor has no ownership in anything, and the phantom stock is normally unsecured. For these reasons, investors do not generally like phantom stock as an investment. It really should be used as a compensation tool.

Do holders of phantom stock get a vote?

The answer is no, holders of phantom stock do not get a vote at shareholder or management meetings. Because of this, management can more easily maintain control of the company while still providing compensation plans based on growth to key stakeholders.

How do you set up a phantom stock compensation plan?

You generally need to take four steps to implement a phantom stock plan at your company.

• First, you draft a plan which all company phantom stock agreements are governed by.
• Two, you draft an agreement to be signed by all participants.
• Three, you obtain approval of the plan and related documents by company management and ownership if need be.
• Four, you send a top hat plan letter to the United States department of labor.

Conclusion.

Phantom stocks plans are a solid motivational tool to keep key employees, board members, consultants, and other stakeholders on board and motivated. They are not perfect tools and should not be used in ways they are not designed to be used. But, if used within their wheelhouse, they are very useful.  If you’re interested in implementing a phantom stock plan for your business, it’s important to have a well-drafted agreement in place to ensure that everyone’s interests are protected. At Forward Law Firm, we have extensive experience in creating and negotiating phantom stock agreements, and can help you navigate the complexities of this type of equity compensation. So, if you’re ready to take the next step and invest in the future of your company and your employees, don’t hesitate to reach out to us today.