Phantom Stock Plan

Refers to a type of employee incentive plan that allows participants to earn benefits that are based on the value of the company's stock

Patrick Curtis

Reviewed by

Patrick Curtis

Expertise: Private Equity | Investment Banking


September 23, 2023

What Is A Phantom Stock Plan?

A phantom stock plan is a type of employee incentive plan that allows participants to earn benefits based on the value of the company's stock. These employee incentive plans are often used in addition to other employee benefits, such as stock option plans.

A phantom stock plan is an employee perk that grants senior management and other chosen employees all of the advantages of stock ownership without actually transferring any firm stock to them. The term "shadow stock" is occasionally used to describe this kind of arrangement.

Under this plan, employees are not given any shares of the company's stock. However, they are given the right to receive benefits based on the value of the company's stock.

These benefits may include the right to purchase shares at a discounted price or the right to receive cash payments based on the value of the company's stock.

This particular employee incentive plan is often criticized for being too complex and providing employees with benefits that are not directly tied to their performance.

However, this can be an effective way to motivate and retain employees.

Employee incentive plans can be a great way to keep your best employees on board. However, they are not without their risks. 

If not appropriately managed, employee incentive plans can create a division between employees who receive the incentive and those who do not. Therefore, if you implement an employee incentive plan, be sure to do so fairly and transparently for all employees.

What are phantom shares and the benefits they offer?

The main benefit of a phantom shares program is that it allows the company to provide an option for employees to defer compensation to gain long-term growth. Phantom shares can be helpful when the company wants to grow and has plans for future expansion but lacks capital. 

The company can offer these benefits by issuing phantom shares without issuing new shares or generating new capital. These phantom shares are just cash deposits in a bank account with no interest.

In addition to allowing employees to defer compensation, phantom shares also give participants who leave their job in good standing additional credits they can use towards their account balance later.

Some of the benefits of phantom shares include:

  • The ability to share in the company's future growth
  • A long-term investment that can produce high returns
  • A sense of ownership and pride in the company
  • A motivator to stay with the company for the long-term

If your company is considering offering phantom shares to employees, weigh all the pros and cons before deciding.

Who is using a phantom stock plan?

Startups and private companies often use these plans to attract and retain key employees. This plan works by setting aside a certain number of shares that will be awarded to critical employees later. 

These shares do not have any actual value until they are vested, at which point they can be sold or traded.

The main benefit of this plan is that it can help to align the interests of key employees with those of the company. In addition, providing employees with a financial stake in the company is more likely to work hard to help the company succeed. 

Additionally, phantom shares can be less expensive and easier to administer than traditional stock plans. As a result, companies use this plan to attract new employees while avoiding the cost and burden of issuing company shares.

Some examples of businesses that use this type of plan are banks, insurance companies, realty companies, and nonprofits.

There are a few different ways that phantom shares can be structured. The most common type of plan is an equity incentive plan, which gives employees the right to purchase shares at a set price in the future. 

Startups and small businesses often use this plan to attract and retain talent.

Why would you adopt a phantom stock plan?

You may want to adopt a phantom stock plan if you have a sizable amount of money that can be saved. For example, if you're planning on opening your own company and don't want to give up all your equity for funding.

Phantom shares are also used in cases where the company doesn't have enough assets or cash to issue shares. This allows companies to save money while still providing benefits for their employees.

Another reason some companies may consider using phantom shares is because they offer tax savings. For example, if the shares are issued as non-voting preferred stock, the company will likely exclude these shares from employee income taxes. 

In many cases, this allows for more capital to be raised at a lower cost than issuing equity through a traditional issuance process.

It is an excellent way to incentivize employees by increasing their financial compensation. It can also help to align the interests of management and employees by increasing the value of employees' shares.

Employers, however, need to consider the administrative costs of implementing a phantom stock plan. This includes naming fees, additional internal accounting fees, and accounting fees associated with issuing phantom shares.

The main benefit is that it can be more affordable than issuing company shares, but an employer has to consider the long-term implications before doing so. 
Filing requirements such as annual reports and shareholder meetings are also required for companies implementing a phantom stock plan.

The Key Difference Between a Phantom Stock Plan vs. a Stock Option Plan

As its name implies, a stock option plan is a compensation plan where company employees receive equity or ownership in the company for their work. It's an option because it gives employees the right (or "option") to buy shares at a predetermined price during a fixed period.

Stock options or annual salary increases are given out as part of an incentive program. In contrast, phantom stock plans don't need to be tied to any particular incentive or a formal way that you can earn them. 

The only requirement for participating in a phantom stock plan is that your company's board must approve it of directors and have at least five people on it who have been with the company for more than one year.

However, like other forms of deferred compensation plans, there are specific tax considerations involved with this type of plan. 
Phantom stock plans are not taxed until converted into actual shares later, meaning you get the benefit of receiving some tax-free income immediately.

Key Considerations

One of the critical factors to consider when choosing this plan is how much ownership you want your employees to have in the company. If you decide not to offer full ownership, you can still benefit your employees by issuing them phantom stock.

It would help if you also considered the tax implications of using this plan compared to an employee-owned company.

It is also important to determine the vesting schedule for the phantom shares. This will determine when and how employees can cash in on their benefits. 

The plan should include provisions for what happens to the phantom shares in the event of a change in control of the company. 

This ensures that employees can still reap the rewards of their hard work even if the company is sold or goes public. Finally, it is important to choose an experienced plan administrator to handle the plan's details. 

This will ensure that everything runs smoothly and that employees can take advantage of the benefits they are entitled to.

These plans are an excellent way for employers to save money on taxes, salaries, and benefit plans while still providing some form of deferred compensation.

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Researched and authored by Jake Heimowitz | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

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