Illusionary Equity Shares
Phantom stock plans, also known as shadow stock, are a popular method used by startups to incentivize key employees and independent contractors without giving away actual equity. These plans are not limited to specific companies or industries, with examples ranging from tech giants like Facebook and Twitter to smaller startups.
How Phantom Stock Works
Phantom stock allows individuals to have a stake in the success of the company without owning any shares. The payouts are typically tied to the company's financial performance, such as its stock price or revenue growth. It's important to note that phantom stock is not a publicly traded stock and does not confer voting rights or ownership of the company.
Benefits for Startups
Phantom stock plans offer several advantages for startups. For instance, they do not lead to dilution of ownership or management control, preserving founders' equity and voting power. Startups also enjoy the flexibility to design and adjust the plan terms based on their needs, and a lower regulatory burden compared to issuing real equity. Additionally, there's a tax deferral for the company until payout, as no shares are issued or taxed upfront.
However, there are also potential drawbacks. Phantom stock payouts are a cash expense that can disrupt cash flow, requiring funds to be set aside for future payments. The contractual obligations to pay specified amounts can be risky if the company valuation grows substantially.
Benefits for Employees
For employees, phantom stock plans offer the opportunity to benefit economically from company growth without owning actual shares or dealing with shareholder responsibilities. There's also a simpler tax treatment for those in complex state jurisdictions because no K-1s or multi-state filings occur with phantom plans.
On the downside, payouts are taxed as ordinary income, often at higher rates than capital gains applied to real equity sales. Employees also lack actual ownership, which means they have no voting rights, dividends, or shareholder protections. Furthermore, payouts may not match the market value timing, depending on the company's liquidity and discretion.
Conclusion
In essence, phantom stock plans provide startups and employees with aligned economic incentives without ownership dilution or complex equity issues. However, the company assumes future cash liabilities, and employees pay ordinary income tax on payouts rather than capital gains. As with any financial decision, it's crucial for both startups and employees to fully understand the implications before deciding to implement a phantom stock plan.
[1] "Phantom Stock Plans: Pros, Cons, and Alternatives for Startups." (n.d.). Retrieved from https://www.investopedia.com/articles/personal-finance/06/phantomstock.asp
[3] "Phantom Stock: What It Is and How It Works." (n.d.). Retrieved from https://www.forbes.com/sites/forbesfinancecouncil/2018/05/17/phantom-stock-what-it-is-and-how-it-works/?sh=62c53e003e11
[5] "Phantom Stock: What It Is and How It Affects You." (n.d.). Retrieved from https://www.thebalance.com/phantom-stock-plans-357132
- In the realm of business and finance, phantom stock plans present an avenue for startups to reward key employees without alienating ownership or control, as they do not lead to dilution of equity and offer the flexibility to tailor the plan according to the company's needs.
- For employees, investing in a phantom stock plan offers a chance to beneficially partake in the financial success of the company, without the obligations and responsibilities that come with owning actual shares, and with simpler tax treatment for those in complex state jurisdictions.
