What is a Phantom Stock Plan and How is it Created?
A phantom stock plan is a way to benefit employees without reducing the company’s equity. It basically enables them to enjoy stock ownership benefits and receive payouts without them having to possess stock.
Phantom stock plans involve a contractual agreement between the employee and employer, giving the employee payments based on the company’s stock value that they can cash at certain times or during certain conditions.
Read the rest of this article to explore the different types of phantom stocks, their pros and cons, how a phantom stock plan works, what’s included in a phantom stock agreement, how to create a phantom stock plan, and how a lawyer can help you with phantom stocks.
What are the Types of Phantom Stock?
The two types of phantom stocks are:
- Appreciation-only stock plans. Under this plan, employees get payments based on the company’s stock value increasing.
- Full-value stock plans. The employee receives a payment based on the company’s stock full value. If the share price decreases, employees will still receive payments.
What are the Pros and Cons of Phantom Stock?
There are advantages and disadvantages related to phantom stocks. These include the following:
Pros
- Employees don’t have to own shares in the company to benefit from its growth.
- Companies can create customized phantom stock plans.
- Employees gain benefits without the company having to share ownership control.
Cons
- Employees lack comprehensive benefits, such as voting rights in the company.
- Employee payouts will be taxed in the same way as their income.
- Uncertainty is involved with phantom stocks because they’re based on the company’s performance. Payments aren’t always guaranteed.
How Does a Phantom Stock Plan Work?
The following steps are included in a phantom stock plan:
- The company creates phantom stock that matches their real share value.
- A vesting schedule is determined. This includes information about how long employees must stay with the company to be able to receive the payments.
- Depending on the company owner’s decision, they might set an event that triggers the payouts, such as a liquidity event.
- When the vesting schedule has been satisfied, the company pays out employees an amount that matches the value of the phantom shares.
What happens if the company’s stock price increases during the vesting period? The phantom shares will also increase, so employees will receive more money. Similarly, if the stock price decreases, so will the phantom share value.
What’s Included in a Phantom Stock Agreement?
A phantom stock agreement is a contract that defines the phantom stock and how it will work. This differs from a phantom stock plan. An agreement is a legally-binding contract that specifies details about the phantom stocks, such as how they’re paid out and valued.
By comparison, a phantom stock plan is a more general strategy. It features the company’s approach to using phantom stocks.
A phantom stock agreement usually includes the following terms:
- Vesting schedule. This will determine when the payout will occur, such as at specific milestones. It’s common for vesting schedules to take place over many years.
- Phantom units. The agreement determines the phantom stock unit value (which should match the value of the company’s stock).
- Valuation process. This section includes information about how the company’s phantom shares are valued. An example is third-party valuation.
- Forfeiture provisions. There are various reasons why an employee might forfeit their units, such as if they breach the contract or resign before vesting occurs.
- Payout schedules. It’s essential for the agreement to specify how and when employees will be paid out, such as if payment is made in lump sums or installments.
- Termination. If an employee leaves the company (whether willingly or not), the agreement needs to state what happens to their phantom stocks.
- Clawbacks. In some cases, a company can reclaim (or “claw back”) their payouts, depending on whether or not certain conditions are met.
- Company changes. What happens to the stocks if the company ownership changes, or there’s a merger? This needs to be specified so there’s no confusion. For example, maybe the company will trigger payout events in such situations.
How Do You Create a Phantom Stock Plan?
When creating a phantom stock plan, companies need to consider the following important aspects.
- Specify all phantom stock terms. This includes how many phantom shares will be provided and which employees will receive them. All this information should be specific and clear to prevent any misleading or confusing ideas.
- Draft a phantom stock agreement. This should be done by a lawyer to ensure that all terms are legally sound, easy to understand, and minimize disputes. You can hire a lawyer from ContractsCounsel, an online legal marketplace that connects clients with vetted lawyers. They will draft a fair, legal, and transparent contract that protects both parties.
- Discuss the plans with employees. Phantom stock plans shouldn’t be one-sided. Employers need to communicate with their employees so that they get all the information about these benefits. This can incentivize them to stay with the company.
- Update the plan regularly. As your business grows (or shrinks), you’ll want to adjust your phantom stock plan. For example, you might want to add or remove employees to or from the plan.
Why Should You Hire a Lawyer for a Phantom Stock Plan?
Hiring a lawyer to help you with a phantom stock plan is advisable. They will review the phantom stock agreement to ensure it’s clear and legal, while also assisting companies to reduce their risks when formulating these plans.
By ensuring phantom stock plans and their agreements are professional and legal, lawyers will help both employers and employees navigate them, especially since phantom stocks can be complex at times.
You can hire a lawyer from ContractsCounsel. All lawyers on the platform have been vetted and they have years of experience in assisting clients and companies with phantom stock plans. They’ll translate complex terms into easy-to-understand clauses that are legally solid to avoid disputes.
