Phantom stock and Stock Appreciation Rights (SARs) have many similarities, making the two seemingly interchangeable to people who are in the beginning stages of exploring options that mimic equity. While both types of compensation are used to incentivize and reward employees without giving them true equity shares, there are notable differences in how they are structured.
Definitions of Phantom Stock and SARs
Phantom stock as a general concept is defined as a promise for future cash. More specifically, it can be broken down into two scenarios:
Full-Value Phantom Stock Plan
A full-value phantom stock plan is defined as a promise for a certain amount of future cash, where that amount is equal to a value in shares tied to the underlying value of the company.
An example of how this might work in practice is a business owner granting an employee 50,000 shares of phantom stock during any period of time during that person’s employment. Years later, the company sells for $1 million and has a total of 1 million shares. To calculate the payout of a full-value phantom stock deal, you would multiply the number of phantom shares the employee holds by the value of each share at the time of sale. In this case, the payout would come to $50,000.
Appreciation-Only Phantom Stock Plan
An appreciation-only phantom stock plan is defined as a promise for a certain amount of future cash, where that amount is equal to an increase in the value of company shares over a period of time.
For example, a business owner might grant an employee 50,000 shares of phantom stock in January 2024. The value of the business at the time the shares are granted is $500,000, represented by 500,000 shares; this means that each share is valued at $1.
In January 2030, the company is valued at $1 million dollars, now represented by the same 500,00 shares (assuming no additional shares were issued); this means that each share is valued at $2. In an appreciation-only scenario, the growth in value between the time of stock being issued and the sale of the company (or another triggering event) is what’s relevant. The change in value per share in this case is $1. Multiply that change in share value by the employee’s 50,000 shares, and the employee walks away with $50,000.
Stock Appreciation Rights
SARs, on the other hand, gives employees the right (as the name suggests) to a potential appreciation in price of stock over a certain period of time, but does not guarantee a right to the stock itself. While phantom stock can promise a portion of the full underlying value of the company, SARs always focus on the appreciation of stock value (similar to appreciation-only phantom stock).
Normally, phantom stock and SARs will be subject to a vesting schedule. However, SARs recipients can often exercise their shares anytime after they are vested, while phantom stockholders usually have to wait for the company to meet a milestone or trigger (like the sale of the company, for example).
Similarities
- Both phantom stock and SARs are classified as deferred compensation and are usually taxed as ordinary income upon payout.
- Appreciation-only phantom stock and SARs are both tied to the potential growth in value of stock during a certain period of time.
- SARs and phantom stock are ultra flexible; vesting schedules, payout triggers and valuation methods can all be controlled by business owners.
Differences
- Phantom stock can offer either appreciation value or full value at the time of payout. SARs solely focus on the appreciation value.
- Phantom stock can be structured to include dividends or even voting rights, while SARs cannot.
- The bullet points above underline the main difference, which is that phantom stock can mimic equity closely, while SARs cannot. Phantom stock can create a sense of ownership and tie to specific company milestones. SARs are a more narrow reward that never include complexities of dividends or total underlying value considerations.
How Phantom Stock Works Within The Modern Agreement for Rewards and Equity
The Reins MARE Equity product is most frequently used as a full-value phantom stock plan. One of the deciding factors for Reins customers is often the valuation process; while appreciation-only plans require a valuation upfront before plan implementation, full-value plans do not. However, the MARE phantom stock product is flexible and can be used for either use case.
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