Want to give equity to valuable employees, but don’t want to give up any ownership in your company? A phantom stock plan is your solution.
Founders often personally finance their startups, making it difficult to offer competitive compensation to key employees or members of management. This poses a problem for startups that need strong leadership and talent because strong leadership and talent do not come cheap. A common solution for this issue is for the founders to issue ownership shares to these key employees, which gives the employees a stake in the company’s success and adds to their compensation without adding to payroll. These employees take pride in ownership, strive to add value to the enterprise, and enjoy a tax-deferred wealth enhancement.
However, some founders do not wish to give any ownership in the company away because adding shareholders to a closely-held company comes with the risk of a disagreement among owners at the most crucial times in the life cycle of a company. For instance, shareholders have the right to dissent against mergers and acquisitions. Shareholders may exercise inspection rights and force privately-owned businesses to produce all of their accounting records—all the way down to invoices and canceled checks. Additionally, shareholders owning a third or more of a company’s stock have the right to petition a court for the involuntary dissolution of the corporation. During times of incredible opportunity or immense hardship, additional shareholders can, and often do, cause trouble.
Generally speaking, phantom stock plans are deferred employee benefit plans. Phantom stock plans are contracts between the company and participating employees designed to parallel actual stock ownership of a company. Under a phantom stock plan, the company grants a certain amount of stock units to key employees or members of management. Each stock unit equals the value of a then-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 to the recipient. Phantom stock plans can also be based on company sales or profits.
Your company can utilize a vesting schedule so that the employees’ phantom stock is paid out over time rather than all at once. Payment of the phantom stock benefits usually occurs upon termination of employment as a result of retirement, death, or disability, and this benefit can be paid out in installments and in either cash or actual common stock of the company. Typically, benefits are paid in cash because the company does not want to give away ownership of the company.
Startups with limited resources but promising prospects should always consider utilizing this form of employee compensation to hire and retain key employees while simultaneously adding value to the company.
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About the Author:
Dallas P. Verhagen is a business attorney and a partner at Verhagen | Bennett LLP. To learn more about Dallas, please click here.
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© 2017 Dallas P. Verhagen — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.