At Reins, we’re on a mission to help small business owners keep their best employees. Our unique framework: the Modern Agreement for Rewards and Equity (MARE) makes this possible. The MARE is a customizable employee rewards framework; notably allowing for phantom stock awards.
Below, we outline some of the customizations available, as well as some important definitions and features of phantom equity.
Customizations
We are constantly iterating and adding flexibility to the MARE. The variables listed below are not exhaustive; reach out to hello [@] myreins.com if you are interested in further customization.
Legal entity type
A basic variable in the MARE, legal entity type refers to your business structure, which is a regulatory classification required by the government of all businesses. The MARE currently supports.
- LLCs
- S-corps
- C-Corps
- Partnerships
You can read more about choosing the right business entity here.
Award Type
Generally, there are two types of phantom stock awards: “full value” and “appreciation-only” and this is the case within the MARE. Appreciation-only awards require a company valuation as they track the value of the award between the date it is granted and the future triggering event. For example, if you award an employee 2% of full value phantom stock and the business sells for $1,000,000, assuming the triggering event is the sale the employee will receive a cash bonus equivalent to 2% of the sale price (~$20,000).
Learn more about full value and appreciation-only awards here.
Triggering event
In the context of phantom stock, a triggering event is the thing that needs to happen in order for the cash payout of phantom stock to occur. For example, if you award an employee 1,000 units of phantom stock, that stock doesn’t turn into cash-in-hand for the employee until the triggering event occurs.
In most cases, that trigger is the sale of the company. In fact, this is the trigger that the vast majority of Reins customers choose. However, phantom stock is flexible and allows for a multitude of triggers, such as:
- Sale of the business
- Specific date in the future
- Termination of employment
- Annual vesting event
Phantom equity “pool”
This feature is the total amount of your company you want to set aside for the employees you plan to award phantom stock. For example, you may choose to set aside 10% of your company for current and future employee phantom stock holders.
Pools can be broken down by:
- Percentage (of fair market value)
- MARE Stock units
How do you decide on a pool percentage? There are no specific rules (other than making sure you don’t accidentally give away a majority of your company). However, you might want to start by asking yourself: what percentage of the future sale of my company would I consider giving to my employees?
You can read more about phantom stock pools here.
Phantom equity percentage allocation
The percentage of phantom stock allocated per employee is one of the most important variables to consider. The decision indicates what percentage of your company you are awarding to a given employee. For example, you may award three manager-level employees 2% each, and two associate-level employees 1% each
A commonly asked question is how to decide on allocation percentages. The truth is that this is more art than science. Factors to consider include tenure, seniority, potential growth, and succession potential. No matter how you break it down, it’s critical to keep track of allocations through a platform like Reins to avoid mistakes like over-allocation.
Vesting schedule & conditions
A vesting schedule is a period of time over which an employee gains ownership of their phantom stock allocation. For example, you might allocate 4% of your company to your general manager. The GM might accumulate 1% every year over the course of four years. The GM would be fully vested and own the full 4% in phantom stock after 4 years.
Note: owning the phantom stock does not necessarily mean receiving cash. The triggering event will determine whether must occur in order for the GM to get 4% in equivalent cash.
You may also choose accelerated vesting conditions that would automatically vest the employees award to 100%. Options for accelerated vesting conditions may include:
- Sale of the business
- Employed after a sale of the business
- Death or disability
- Termination
- Retirement
You can also include milestones which could be financial or custom goals that need to be reached before the phantom stock is vested.
Profit sharing
Profit sharing plans let employees receive a portion of your company’s profits, typically payed more frequently on a shorter time horizon than phantom stock, which directly connects employees’ financial success to the company’s success.
Within the MARE framework, we offer a separate product to offer profit sharing to your employees called MARE Profit. Features of MARE Profit include:
- Formula:
- Based on phantom stock
- Based on salary
- Based on milestones
- Custom
- Frequency
- Annually
- Quarterly
- Bi-annually
- Profit pool (based on percentage of net profits)
- Milestones
- Financial
- Custom
Learn more about profit sharing and if it’s right for your company.
Key Definitions
Phantom stock
In the most simple terms, phantom stock can be described in the following ways:
- A much less complicated version of traditional stock
- A slightly more complicated cash bonus
- The right to receive a cash payment at a future date. That date is usually linked to a milestone – often, it’s the sale of the company. The “future” element aligns the employee’s financial interests with the long-term success of their employer.
For a more detailed dive into phantom stock, take a look at this blog post.
Non-qualified deferred compensation
Phantom stock is a type of non-qualified deferred compensation (NQDC) benefit. Because of this designation, many of the reporting and tax rules that come with qualified benefits don’t exist. As a non-qualified benefit, phantom stock is more affordable, flexible, and easier to implement than other benefit plans.
A key feature of NQDC plans is that payments are delayed until a future date. In the case of phantom stock, that future date is often the date that the company sells.
Tax implications
As a type of NQDC, phantom stock is non-taxable until there is an actual cash payout. Employees do not pay taxes when the stock is granted. When the payout does occur, employees are taxed at an ordinary income rate, while employers get a tax deduction.
Forfeiture of phantom stock
In the MARE specifically, employee forfeiture of phantom stock occurs if the employee departs the company (whether voluntarily or through termination) before the triggering event associated with a cash payout. As written, the forfeiture includes both vested and unvested phantom stock.
