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Does a Phantom Stock Plan Make Sense? Three Considerations

Situation: The CEO of a privately held company wants to share company success with employees. An option that she is exploring is phantom stock. The objective is to engage employees in company success. Does a phantom stock plan make sense?

Advice from the CEOs:

  • Why would you use phantom stock options instead of real stock?
    • Phantom stock options are popular in the tech sector. Phantom stock confers the right to receive cash at a future point in time, typically a share of the proceeds received upon the sale of a company.
    • The principal difference between phantom stock and real stock, is that real stock must be issued in exchange for cash, property or past services. There is also a tax consequence to the receipt of real shares. When shares are issued in exchange for past services the employee must recognize taxable income, just like wage compensation. Employees may be disappointed to learn that they may face taxable income based on the fair market value of their shares received without compensating cash to pay the tax.
  • Let’s assume that the objective is to increase employee engagement as they observe the value of the shares increasing with company success over time.
    • Under phantom stock programs the value of the company is pegged on a periodic basis, based on a pre-set formula developed by the company.
    • In some cases, employees can “sell” their phantom stock back to the company for the differential between the price when they were awarded the stock and the current pegged price.
    • The structure of the program is determined by management based on company objectives.
  • Employees frequently don’t have the cash to purchase real stock or options at a fair price given the value of the company. Using a phantom stock plan, a company can offer the rewards of stock ownerships without a purchase requirement or tax implications at the time of award. Employees can be apprised of the value of their phantom stock based on a periodic internal accounting exercise.