A phantom stock plan may be an incentive that you will want to consider. When considering utilizing a phantom stock plan or any other incentive plan to financially motivate a key employee our first question should be, “Can this employee measurably increase the value of the business?”
If the answer yes, then the owner designs an incentive plan to motivate the manager to behave in a way that fosters an increase in business value. This may seem elemental, but it is not. Too often we see stock awarded to a sales manager when a cash-based plan directed at increasing sales is not only more effective but also more appreciated.
You should also keep in mind your long-term ownership transition plan to determine whether or not this particular employee is a potential for future ownership and if a phantom stock plan will further your objectives.
Let’s look at how one owner solved the problem of matching the incentive to his desired result.
During an annual performance review, Bob Greenleaf’s Chief Operating Officer expressed an interest in owning part of the company. Bob was really not interested in taking on a co-owner because he eventually wanted to transfer his company to his daughter. He didn’t want to sell or bonus stock but he didn’t want to lose his key employee. Bob was at an impasse. His CPA had told him that it rarely made sense to mix ownership among family and employees. On the other hand, Bob’s COO wanted the look, the feel, and financial rewards of stock ownership.
Bob wanted a way around this impasse. Bob’s advisors suggested that, instead of ownership and instead of just a cash bonus, Bob create a Phantom Stock Plan.
A Phantom Stock Plan can help meet both the needs of the key employee and of the owner, because it gives employees something that looks like stock, grows in value like stock, and can be turned in for cash just like stock, but is not stock.
As employees strive to make the company more valuable, they make their interest in the Phantom Stock Plan more valuable. Typically, phantom shares corresponding to shares of stock-but not representing actual ownership-are allocated to the participating employees’ accounts. As the value of true stock increases, so does the value of the phantom stock. When the employee terminates his employment, the company typically pays him the per share equivalent value of each of the phantom shares vested in his account. The amount paid is deductible to the company.
The success of a Phantom Stock Plan depends on careful design of vesting, forfeiture, payment schedules and funding devices.
Phantom Stock Plans also work well when the key employee does not want to be an owner. This is a much more common situation than owners think. Many employees do not want to be owners. They donâ€™t want the risk and stress of ownership. Phantom stock gives these employees the feel, look and some of the financial rewards of ownership, with less risk.
Another suitable situation for the Phantom Stock Plan is when the owner wants to reward a long-term employee who has contributed to the growth and value of the company. This is most appropriate when the employee is within ten years or so of retirement. In this case, it simply makes no financial or tax sense to sell stock to employees when, within a relatively short period of time they are going to turn around and sell it.