A phantom stock equity pool is a certain number of hypothetical shares that are set aside by a company so that ghost stock can be issued to current and future employees, consultants, contractors, or nearly anyone who provides a service for the company. The Modern Agreement for Rewards and Equity (MARE) allows you to fully customize and allocate equity within a phantom stock pool, though a pool is not required.
Setting aside shares
The MARE is generally used as a full-value plan (though it can be used as an appreciation-only phantom stock plan as well – more on that below). That means that when a small business owner is determining the size of the equity pool, they should ask themselves: what percent of the full underlying value of the company would I be willing to part with and share with employees upon a future sale? At Reins, we’ve seen percentages range from 5% to 30%. However, it’s more common to see a middle range of 10% – 15%.
Some other items to consider when choosing a pool size include growth projections, number of employees you currently want to incentivize, number of employees you may want to incentivize in the future, and percentage allocations for different employees (e.g., a key, long-term employee versus a newer employee). When considering specific employee allocation, owners should take roles, responsibilities, tenure, and potential successors into account.
Choosing a trigger event
The MARE’s phantom stock tool is extremely flexible, making it ideal for small businesses. One example of the adaptability of the plan is that owners can choose nearly any payout trigger imaginable. The most common one we see is the sale of a company (upon a sale, employees are paid out their stock based on the value of the company when it’s sold). However, owners can define a sale or change in control however broadly or narrowly they’d like. You might also choose performance, time-based, or milestone triggers, all of which can range from very simple to very complex.
A note on appreciation-only phantom stock
While the MARE can certainly be used for appreciation-only phantom stock as an alternative to a full-value plan, small businesses will have to pay for a company valuation at the time of distributing phantom stock, as opposed waiting until the time of sale for a valuation. Appreciation-only phantom stock means that employees’ shares are valued based on the growth between the time they are allocated stock, and the time the company sells, which requires at least two valuations. (In reality, owners will likely need many more valuations in order to keep the value updated as employees come and go.) Full-value plans mean that owners are granting stock at the full underlying value of the company, and only one valuation is required.
Phantom stock pool management
It is important to keep a close eye on the phantom stock pool and allocation of it. You’ll want to take dilution into account; depending on the path you choose, employees either maintain their shares as is or have to strive to be granted new shares in order to avoid dilution; there are pros and cons to both approaches. Most importantly, you’ll want to maintain transparency around how the pool works, how it might change, how valuation affects employees, and what a trigger event means for a pool payout.
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