By Maurie Cashman
Last week we discussed some of the benefits of Phantom Stock Plans. This is a complicated enough subject that I wanted to spend another week digging a little deeper into some of the intricacies of these plans. There are several key issues that must be resolved before establishing a Phantom Stock, or any other employee incentive plan. We’ll discuss a few of them here.
- Phantom Stock is not a direct vehicle for the transfer of ownership of your company. It is an incentive plan that may allow you to handcuff key employees to the company and the company’s performance, thereby enhancing the value of the company. It may be a part of an overall Ownership Transition Plan, but it must be carefully constructed and executed to be sure that it supports the ultimate transition in ownership.
- You are providing a benefit that is directly tied to the value of your company. Most owners of small to mid-sized companies do not have a good understanding of their company’s value. There must be a plan put in place for valuing the phantom stock so that, when it is time to be paid out, there is a clear understanding and a fund set aside to pay out these benefits.
- Phantom Stock Plans are not a deductible event until the payout is made, at which point the employee recognizes the payout as income and the company as an expense. This makes the valuation critical as it is may come under the scrutiny of the IRS.
- It is very important that solid projections are made for the growth of the company and how that growth will be achieved. The elements of the plan must be closely aligned with the reason for growth. There is significant danger here. If the plan is to grow the company primarily through capital expenditure then a phantom stock plan that will require you to accumulate cash at the same time that you need to make capital expenditures may not be appropriate or warranted.
- Similarly, it is important to calculate how and when Phantom Stock vests and will be paid out. You may want to establish a vesting plan to insure that the employee has to stay long enough to truly impact the performance of the company. Just as importantly, you must have a plan for managing the cash-flow that will take place when the employee leaves and you must pay out the phantom stock.
- Be careful not to give out too much phantom stock to early participants as it may not leave you the ability to allow future key employees to be hired and given the same benefit, affecting your hiring competitiveness.
Communication Issues
Communication of the plan to participants and gaining buy-in is absolutely critical if the plan is to work.
- Make sure the plan is spelled out in detail. A corporate attorney once told me “if it’s good enough to say, it’s good enough to put in writingâ€. So make sure you do so.
- Discuss the design of the plan with the employees who are going to participate and get their input. Nothing builds buy-in like having the parties involved discuss the details and agree on how they are to be handled.
- Consider getting some outside input into the discussion. You are likely to do this only once while there are advisors that have been through this multiple times. Also, consider the risks involved in doing all of the design and communication with your employees if problems must be resolved during the process.
- Model the plan under different circumstances. These plans can sound great when looked at in today’s light. What will they look like if the company performs significantly better or worse? What will happen if the circumstances of the corporation, industry or employee change?
- Have an attorney and a CPA experienced in such plans review the plan documents and approve all final documents prior to signing.
There are many technical aspects involved with a phantom stock plan. I am touching on a few broader issues to consider the past two weeks. This can be an excellent plan and one that you may be considered. Be sure you have adequate resources on your team before you dive in.