Explaining Phantom Equity To Your Employees

February 5, 2024

If you’re reading this blog post, you might be in the process of implementing a phantom equity plan for your employees. You’ve done your research, put together an agreement, and have an implementation plan ready to go. While you might know phantom stock inside and out, do you know how to explain the intricacies of this benefit to your employees? Communicating your new company incentive in a clear, informative way is arguably the important part of carrying out a phantom shares plan.

Explain what phantom stock is—and what it isn’t

“Phantom stock” as a term isn’t the most clear descriptor of what employees will actually be receiving. To combat any misconceptions, start off by sharing the basics of what their new benefit is and what it isn’t.

What it is:

  • A way for employees to receive some of the benefits of stock ownership without actually owning stock.
  • An incentive plan that serves as a way to tell your staff that you find them valuable and want them to stick around for the long haul.
  • A means of aligning business owner and employee interests (growing the company and finding continued financial success).
  • A promise for future cash equivalent to the value of a certain number of company shares.

What it isn’t:

  • Actual equity: phantom shares don’t provide employees with any ownership rights in the company, unless otherwise stated in the agreement. There are generally no voting rights or dividends associated with this type of stock ownership.
  • A short-term cash bonus: phantom stock is not a promise for cash today. It’s a future financial benefit, triggered by a specific milestone like company performance or a future event (like a sale).  However, many small business owners choose to add a profit sharing clause to their phantom stock agreement as a way to balance out the long-term nature of phantom shares.
  • Tax advantaged: while many forms of employee equity including ESOPs have capital gains tax advantages for employees, phantom shares are taxed as ordinary income, since there is no actual transfer of stock.

Discuss why you chose phantom stock and how it fits into your broader incentives plan

Be candid with your employees about why you chose phantom stock. For example, some small business owners want to incentivize staff with owner-like benefits, but can’t due to the structure of their business, the cost associated with implementing a traditional stock plan, or some combination of the two. Phantom stock is often viewed as a happy and achievable middleground between true ownership and zero stock benefits.

You may also want to touch on how phantom stock fits into your current benefits plan. Does it complement short-term bonuses or profit sharing? Are there other perks you considered or plan to consider in the future? Why is retention important to you as an employer and what are you doing to optimize for it? Your employees will appreciate the transparency of a conversation like this.

Walk through the agreement

Simple phantom stock agreements are surprisingly concise for legal documents, but they can seem complex and overwhelming upon first glance. Be prepared to walk through the most important clauses within the phantom stock agreement with your employees, and be sure to explain each in layman’s terms. Some of the most helpful terms to go over include the concept of vesting and your chosen vesting schedule; the triggering event (for example, the sale of your company); the size of your phantom stock pool; and that employees must be employed at the company at the time of payout.

Offering to walk through the document with employees individually, having a human resources officer available, or providing an annotated version of the agreement that breaks down the legal jargon into plain language can also go a long way.

Dig into FAQs

You can expect your employees to have many questions about their new benefit. To preempt some of them, consider putting together an FAQ handout. Some example questions to cover include:

  • How does phantom stock differ from ESOPs or RSUs or 401ks?
  • Are shares of current employees’ phantom stock ever at risk of dilution?
  • Is a sale of the company imminent or is it decades away? Relatedly, what is your broader succession plan?
  • How is the value of a phantom stock unit determined?
  • Is everyone at the company being granted phantom shares?

Holding an FAQ session where employees can ask questions about their phantom shares in an open forum is another way to educate your staff and make them feel empowered when it comes to their owner-like benefits.

Provide additional resources

A final step in your phantom stock communication plan should involve the promise of additional resources. While you’ve likely spent weeks, months or even years learning about employee ownership benefits like phantom shares, the concept is probably brand new to your employees. Encourage them to take their time reading their agreements before signing them. It’s also a good idea to encourage them to talk to their own financial and legal advisors, or to make yours available should your company have those resources.

If you work with a phantom stock implementation company like Reins, you can have your employees direct their inquiries to customer success specialists who will provide guidance on some common questions.

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