Introduction
Issuing phantom stock to key employees as a retention tool is a benefit for both the company and the employees who partake in such plans. The company benefits from motivated staff who work hard and want to stick around for the long haul. Employees benefit financially from the company’s success, fostering a sense of ownership and motivation.
A fundamental component of setting up an effective phantom stock plan is the phantom stock vesting schedule. When you’re granted phantom stock subject to a vesting schedule, it’s important to comprehend the details of how and when you can capitalize on this benefit. Typically, departing the company prematurely might mean forfeiting unvested equity, significantly impacting your financial gains.
This post helps explain what vesting schedules are, their benefits, and how they work.
What Are Phantom Stock Vesting Schedules?
Vesting is a strategic tool that aligns company success with employee retention and financial interest. Simply put, phantom stock vesting schedules outline the timeframe that employees will earn shares of equity.
Vesting is a mechanism that allows an employee to earn equity over a specified period of time, or to collect equity when meeting certain milestones. Incremental earning and working towards a final equity award is a retention mechanism, incentivizing employees to stay with the company until they are fully vested.
Vesting ensures staff don’t get all of the shares at once. With each month or year they work at the company and contribute value, employees earn a set percentage of equity. They typically become fully vested in these shares over a period of years, incentivizing long-term commitment.
Common terms used in describing vesting schedules:
- Grant Date: The official date when phantom stock is issued (or granted) to the employee.
- Vesting Period: The total duration of time which the employee accrues ownership. It’s common for a stock grant to have a total vesting period of four years, however all plans are unique and a few examples are illustrated below.
- Triggers: A vesting trigger is any event that must occur for stock to vest, entitling equity to the owner. The most common vesting trigger is a change of control (i.e. the sale or acquisition of a company by an outside party).
- Vesting Increments: Since stock vests over time, vesting increments indicate the time periods at which new ownership accrues. It’s common for companies to use yearly or monthly increments. See examples outlined below.
- Accelerated Vesting: Accelerated vesting lets an employee access their granted equity at a faster rate than the original vesting schedule. Common accelerated vesting triggers include an employee being employed at the company at the time of a sale, death or disability, and retirement. Learn more: What Is Accelerated Vesting and How Does It Work In the MARE?
Now that we’ve established what vesting schedules are and common terms to explain them, let’s explore the benefits of vesting schedules.
Benefits of Vesting Schedules
It’s no surprise that both the company granting phantom shares and employees receiving them benefit from such plans. With an underlying goal of loyalty among employees and keeping them engaged and focused on the company’s success, phantom stock plans are a great way for employers to keep top-performing employees at the company while employees reap financial, ownership-like rewards.
A key component of phantom stock plans are vesting schedules. Vesting schedules are beneficial as they clearly define and encourage employees to remain at their company for longer periods of time to capitalize on vested benefits, reducing employee turnover and encouraging longer job tenure. Using vesting schedules is a win-win for companies and their staff that partake.
Vesting schedules are clear goals outlining rewards earned at certain points in time, or after specific milestones. Understanding how vesting works at your company is important because it can influence how long you decide to stay with your current employer. Check your employer’s phantom stock vesting schedule in your plan to understand what terms they expect of you.
How Do Vesting Schedules Work?
Vesting schedules are commonly used in stock option plans, retirement plans, and other forms of compensation to align the interests of employees with the long-term success of the company. They encourage loyalty and performance by ensuring that employees receive the full benefits of their compensation package over time. It’s important for individuals to be aware of the vesting terms when accepting a job or participating in such programs since it can have a significant impact on their overall compensation and tenure decisions.
In the most simple terms, vesting schedules define what conditions need to be met in order to receive financial compensation: the conditions are typically work tenure in months or years, and/or milestones such as the sale of a business.
Note that vesting schedules are independent of payment triggers which define when a payout occurs. Typical payment triggers include: deferred until the company sells, on a specific date, or on annual vesting events.
With background on how vesting schedules work, let’s look at a few examples.
Examples of Vesting Schedules
All plans that utilize vesting schedules are different. Some might include cliffs (waiting periods before shares are vested), others might not. Some might be time-based while others could be only milestone-based, or even a combination of the two. With a wide range of flexibility in regards to vesting schedules, it’s useful to see some real world examples. Here are common, hypothetical examples of three different vesting schedules related to phantom stock:
Vesting Example 1: Chris is part of a plan that offers 1,000 phantom shares that vests annually over 4 years. This means from the time the phantom stock is awarded to Chris, his vested percentage will be 0%, and increase by 25% on each annual anniversary of the Grant Date. On the one year anniversary of his grant date, he’ll vest 25% (250 shares). He must work one more full year to earn 50% (500 shares), 3 years for 75% (750 shares) and finally on his 4th year he will have earned the full 100% of the stock awarded to him (1,000 shares).
Vesting Example 2: Sarah is part of a 4 year vesting plan that offers 4,000 phantom shares which vests monthly. In this case, her vested percentage will be 0% on the Grant Date, and will increase by 2.08% to a max of 100% on each monthly anniversary of the Grant Date. Unlike Chris’ plan in example 1 above which vests annually, Sarah vests new shares each month.
Vesting Example 3: Alex’s plan is the same as Sarah’s, however he has an accelerated vesting clause stating he gets 100% if he’s employed on the date of a change in control (company is sold). Let’s say the company sells in month 40. In his case, since the company sells, he doesn’t need to stick around the entire four years to vest 100% of his shares.
Custom Vesting Options in the MARE
The MARE phantom stock agreement offers a unique benefit to small business employees that is far more simple and affordable than alternatives.
The MARE is designed to be flexible; a small business owner might choose to create a plan that aligns with specific company goals or employee preferences. For example, phantom equity can be tied to milestones and tailored to employee tenure, performance, role, and more. This sort of flexibility can’t be found in typical stock plans.
The MARE can be utilized to implement either a time-based or milestone-based vesting schedule. While the vast majority of Reins customers choose time-based vesting, the single trigger that is most commonly used with a milestone plan is the sale of a given company.
Found in the Plan Features section our the Reins platform, custom accelerated vesting options are available within the MARE, however here are standard accelerated vesting conditions provided:
- Upon a sale (while employed)
- Employed 6 months after a sale
- Employed 12 months after a sale
- Upon death or disability
- Upon termination (other than for cause)
- Upon resignation (dut to good reason)
- Upon retirement
These accelerated vesting parameters are flexible; for example, small business owners can choose how many months following an acquisition an employee needs to remain with the company, or what retirement age is appropriate and applicable to their company and employees.
Furthermore, small business owners can define what the payment triggers are including on the annual vesting event, on a specific date, deferred until a sale, and more.
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