At its core, employee share ownership is employees holding shares of the company they work for. The amount allocated can be based on the salary scale or length of service or something else.

On top of that, the founders have to decide if they want to allocate shares, options or phantom options. Below is a comparison table which can help you decide.

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The shares from the ESOP must vest before the employees can receive them. A vesting schedule refers to a period of time before shares are unconditionally owned by an employee. The vesting schedule usually has 2 defining parameters: a cliff, and a vesting period. A cliff means that no options are vested during the cliff period 1 year is common , and a vesting period is the time it will take for the asset to be completely owned by the employee.

If the employee leaves before the first full year, he will not own any shares. In recent years, new vesting plans have emerged. Another plan is performance-based vesting, which means employees are only given stock options if they reach certain targets. Phantom stock is a tracking vehicle for company growth. It is independent of the type of business for which it is applied.

Phantom Stock

For employees, phantom stock allows the employees to defer paying income taxes on the phantom stock and its appreciation. Phantom stock plans are very flexible. They can accommodate a wide range of program options. When a company decides to move forward with a phantom stock plan, it needs to decide on various key plan provisions including the following:.

There are two questions that must be answered when considering why a company would offer a phantom stock plan. The first concerns why a company would offer any long-term incentive plan LTIP of any kind? Once that question is decided affirmatively, one can then move on to consider whether a phantom stock plan is a right plan for your business. An LTIP is a plan designed to accomplish multiple objectives.

A long-term plan is fundamentally different than a short-term plan.

Phantom stock

Short term plans typically focus on cash bonuses for outstanding performance over a quarterly to annual period. Short term rewards systems may include middle and lower level managers. These plans offer relatively rapid recognition for hard work and diligence. Long term plans involve only those at higher levels of management. Many public companies come under criticism for thinking quarter to quarter. LTIPs encourage managers to think long term. These plans reward key managers for taking a short-term financial hit in favor of a long-term gain. In short, LTIPs encourage key staff to think like company owners.

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LTIPs serve to retain talent. An LTIP helps to make a private company compensation package competitive with a public company capable of offering stock incentives.

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LTIPs require policies and procedures in writing. Everyone involved in the process has access to the rules of the program. A written program instills a sense of fairness and equity in the program. This encourages the target audience to buy into the program. Having determined that a long-term incentive plan will be advantageous, the question turns to what type of plan to implement.

Privately owned companies with a requirement that ownership not be distributed beyond a certain few or one owner require a plan that does not involve stock. Tax considerations always play a role. The phantom stock plan allows key company personnel to own something that has many of the characteristics of the stock. It tracks company performance, sometimes pays a dividend, and has a definitive value but it is not stock. The phantom stock becomes a liability that the company must eventually convert to either cash or company stock.

We're here to help you negotiate the legal challenges you'll face as our cities change. Tech, Media and Comms. In Spain, start-ups have not only revolutionised the technological innovation and investment processes, but also the way to remunerate talented employees. The lack of liquidity available to pay employees requires entrepreneurs to find new ways of attracting and keeping talent, inspired by the stock option plans used by American start-ups.

Long-Term Compensation: Real Equity or Phantom Stock?

The majority of our start-ups use phantom shares model, as a consequence of tax and legal matters. The Spanish entrepreneur movement is influenced by start-ups in the US, where the flexibility of their corporate laws and an adequate tax framework allow remuneration of talented employees through plans to acquire shares of the start-up. Stock option plans have two main benefits: i attracting talent without impacting the company's cash flows and ii aligning employees with the interest of equity holders.

However, the legal and tax differences with the US system make it difficult to implement these plans in a Spanish private limited liability company S. Therefore, in Spain, unlike other jurisdictions, employees do not receive stock options but phantom shares, that is, the right to a cash payment based on the price of the common shares of the company at a given moment.

Like all private limited companies, a start-up's share capital is divided into shares participaciones sociales. Using shares as a method to remunerate employees in a private limited liability company is subject to several legal obstacles, such as limitations on the acquisition of treasury shares; limitations on the sale price of such treasury shares; approval by the general shareholders' meeting to create new shares; or formalization of resolutions to increase the share capital by means of a public deed that needs to be subsequently registered with the Commercial Registry.

All these requirements increase the cost and complicates the use of regular stock options to reward employees.

Phantom Stock Plans in Privately Held Businesses | SHG Planning

Additionally, certain scholars consider that stock option plans are exclusively reserved for public limited companies S. In any case, even though the aforementioned limitations greatly complicate the implementation of stock option plans in private limited companies, the main obstacle is tax related, since the remuneration through stock options is considered as salary income and, therefore, it is subject to high tax rates. To make things worse, upon exercise of the options, the employee usually receives illiquid shares, but is required to pay taxes at the general rate of salary income for the difference between the strike price and the fair value of the shares at the time they are delivered to him.

Therefore, the way to remunerate talented employees in Spanish start-ups, is through phantom shares plans, by means of which employees receive a bonus or cash payment based on the price of the common shares at the time of the liquidity event or sale of the company. This sidesteps the corporate complexity of implementing a regular stock option plan, as well as the tax issue derived from a lack of liquidity to pay the corresponding income tax.

Phantom shares, like any other incentive plan, are subject to the fulfilment of certain milestones, usually permanence in the company. Thus, rules on bad leavers and good leavers are common practice. Generally, a bad leaver is someone who voluntarily leaves the company or is terminated by cause before the end of the permanence period. Contrariwise, an employee who leaves the company for any other reason unfair dismissal, retirement, illness… is considered a good leaver. The importance of the distinction between good and bad leaver lies in the fact that a bad leaver usually loses all his phantom shares even those that have already been vested and, consequently, all remuneration rights deriving from said phantom shares.

However, the good leaver usually keeps all phantom shares vested until the date on which the employee leaves the company, only forfaiting unvested phantom shares. Upon a liquidity event or sale of the company, the holders of phantom shares are entitled to receive a bonus per phantom share based on the price of common shares.