If you are a company owner contemplating equity for your employees, or you are an executive with equity compensation in your sights - phantom stock may be part of the conversation. In either case, here's what you need to know.
How Does Phantom Stock Work?
Phantom stock plans essentially give employees the financial benefits of owning shares without actually having ownership in the company.
The number of shares an employee receives is often based on the perceived value of the individual to the organization, allowing for different amounts of shares to be granted to different employees.
Shadow stock may be granted upfront or over time, depending on the objectives of the company and its shareholders. The value of phantom stock mirrors the value of a firm's stocks, so the value will fluctuate based on company results.
Once a phantom stock plan is set in place, employees may be subject to a vesting schedule before they see a financial payout. Common vesting periods are between two and five years, although time periods are usually customized to match goals and objectives.
Types of Phantom Stock
There are two main types of phantom stock, appreciation only and full value.
1. Appreciation Only
Phantom stock that is “appreciation only” does not include the value of the underlying shares. Rather, it includes the increase in stock value over the time period the shares are held. If a company’s phantom stock appreciates over time, employees receive a cash payment equal the difference between the original price and the appreciated price. This structure serves as an incentive for phantom stock holders to add value over time.
2. Full Value
If a stock is “full value,” it includes the underlying value plus the amount the stock increased over the holding period. This essentially serves as a deferred cash bonus program. At some point, active employees will receive a cash payment that equals the value of the original shares plus the appreciation of the stock.
Important Considerations
Like everything, there are pros and cons to consider regarding phantom stock:
Pros of Phantom Stock
Phantom stock can be an effective tool to keep key executives and employees on board over the vesting period. By giving executives and employees equity-like incentives, they will be motivated to act like owners and boost overall productivity. Additionally, existing shareholders won't be diluted. In short, phantom stock plans allow owners to make significant, but limited investments in their key people.
Cons of Phantom Stock
Implementing a phantom stock plan requires third-party assistance to design and administer the plan which will incur costs to the company. Also, Phantom stock holders don't receive the same rights and benefits of actual shareholders. This may cause the company to have difficulty retaining their industry's top talent.
Whether you’re a business owner looking to update your benefits package or you’re a high-level executive weighing your options, keep the above considerations in mind. Before making a decision, speak with us first to determine if this could work for you.
This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.