Here at Reins, we’re on a mission to help small business owners keep their best employees. A great way to do that is by utilizing the Modern Agreement for Rewards and Equity (MARE). The MARE is a customizable employee rewards tool; one of its most popular components is our phantom stock template. 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, and C-Corps. You can read more about choosing the right business entity 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, including tenure and project milestones. If you’re interested in discussing an alternate trigger to the sale of your company, please let us know.
Phantom equity pool percentage
This variable is the total percentage 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.
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 profits from the future sale of my company would I consider giving to my employees?
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 + cliff
A vesting schedule is a period of time over which an employee gains ownership of their phantom stock allocation. Relatedly, a cliff is the period of time that must pass before vesting can begin. For example, you might allocate 4% of your company to your general manager. The GM might accumulate 1% after one year, and the remaining 3% over the course of the following three years. The GM would be fully vested and own the full 4% in phantom stock after 4 years.
Owning the phantom stock does not mean receiving cash. The trigger event must occur in order for the GM to get 4% in equivalent cash.
Profit sharing
Profit sharing plans let employees receive a portion of your company’s profits, which directly connects employees’ financial success to the company’s success.
If you choose to include a profit sharing component in your phantom stock agreement, know that we’ve designed the feature to be a simple, one-paragraph clause that operates as an informal bonus arrangement. This was intentional, for ease of use and to better the overall employee offering with a short-term incentive to balance the long-term one (phantom stock). If you’re looking for something more specific, we also offer milestone or time-based profit sharing.
The language of the profit sharing clause indicates that profit sharing is discretionary. We often get asked why an employee should trust that an employer would pay out a discretionary bonus. We’re confident that if an employer is willing to use Reins to reward employees, that they are willing to stand by what’s in the contract. Take a look at our blog post on the importance of the psychological contract between employers and employees to learn more about building trust at your company.
Definitions and features
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.
Interested in implementing a phantom stock plan at your company? Take a look at our free MARE phantom equity template.
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