Phantom Stock – Profit Distribution & Control of Equity Interest

Phantom Stock? Funny Name, Great Idea

Article by Joanne Cassidy

Successful businesses need to attract and retain highly qualified employees in order to remain successful.  Sometimes a competitive salary alone is not enough to attract talented managers.  They demand, and often get, shares of stock or other equity interests in the company.

Equity Interest

As a business lawyer, I always tell my clients not give away an equity interest in the company unless they absolutely have to.  An ownership interest usually entitles the employee to have access to the company books and records, gives him voting rights and creates some sort of fiduciary duty on the part of the business owner.

So, how does a business owner provide the necessary employee incentives and at the same time retain full ownership of his company?  The dilemma can be solved with the adoption of a Phantom Stock Plan.

Phantom Stock Plan

A Phantom Stock Plan is a contract between the company and the employee which entitles the employee to participate in distribution of profits or other company distributions such as dividends or proceeds of the sale of the business.  Phantom Stock does not confer an equity interest or voting rights or create a fiduciary relationship between the employer and employee.  It is simply an unfunded bookkeeping entry of the number of units or “shares” given to the employee which will determine the amount of his distribution. The Phantom stock mirrors actual stock in that funds are distributed to the employee to the same extent and at the same time that they are distributed to the equity owners of the company.

A typical Phantom Stock Plan will contain certain vesting provisions, based either on seniority or the attainment of certain goals.  The employer will usually want to know whether the employee performs as expected prior to being obligated to issue distributions to him. The Plan may also tie the benefit to continued employment, or perhaps the eventual retirement of the employee.

Attract and Keep the Employee

The amount of distribution to the employee is often based on the amount of profits earned during a particular time period.  It may also be an amount based on the increase in value of the company over a particular period of time.  After all, the purpose of the Plan is to incentivize the employee to stay with the company and to help it grow.

Reward the Employee and Maintain Full Ownership

A Phantom Stock Plan can be structured in a variety of ways so long as it rewards the employee for adding value to the company over the long term, while allowing the business owner to maintain full ownership and control of the business.