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Disclaimer
 Phantom Stock - Sharing Growth with Employees Companies, and in particular closely held companies, often want to give key employees a sense of ownership in the Company as an incentive to increase profits and profitability. At the same time, shareholders of closely held companies are sometimes reluctant to share the real equity with persons outside the immediate ownership group, often the family. One solution to this problem may be the use of "phantom stock", a compensation arrangement which allows the phantom stockholder to share in the economic growth of the Company while not necessarily participating in corporate decision making. The basic structure of a phantom stock plan is for selected employees to be awarded a number of phantom shares of Company stock. Although no real shares are issued (and no purchase price is paid for the phantom stock), these phantom shares carry with them economic interests in the Company comparable, although not identical, to the Company's common stock. A phantom stock plan works like this... Under the terms of a plan, a formula is established for valuing the Company's stock. Such a formula can be based, for example, on book value, a multiple of earnings, a fair market value as determined by appraisal, or any other method selected by the Company. We often recommend, whatever formula is used, that compensation and benefits paid to shareholder-employees be excluded from the calculation to insulate such matters from employee concern (and to avoid the necessity of having to disclose such matters to employees). Employees are then granted phantom shares. Assuming that there are 100 shares outstanding and the employees are to have a 10% phantom equity interest in the Company's growth, 11 phantom shares will be granted so that the total number of equity "units" is 111, i.e., 100 real shares and 11 phantom shares. On the date of grant of phantom stock, the formula is applied to value the Company which value is divided by the number of equity units outstanding so that the phantom stockholder's "basis" in his or her stock is determined. Depending on the terms of the Plan, participating employees may also share in distributions made to shareholders proportional to the equity units. Thus, if a corporation declares a dividend, or makes a distribution to shareholders a proportional "bonus" is paid to the phantom stockholders. Typically, the plan provides that upon the occurrence of a specified event, usually involving the termination of employment, the employee's phantom stock is redeemed by the Company. The same formula as was used to determined the phantom stockholder's basis is again applied and a "selling value" is determined. The employee is then entitled to receive the amount by which the selling value of the phantom shares exceeds his or her basis. The terms for the payout, as well as vesting periods, are specified in the plan. If the event causing a redemption of the phantom stock is a sale of the Company or some other event which establishes an arm's length value of the Company, that value is substituted for the formula valuation and the payout is made to coordinate with the payments on the underlying transaction. Because phantom stock is only a "phantom", the holders of the phantom stock are not entitled to vote, to access the Company's books and records (except as they might apply to the calculation of the value of the phantom stock at time of repurchase) or to bring a shareholder's derivative action if they are not happy with management's performance. They remain employees and the phantom stock entitlements are merely compensation arrangements. There are two other distinct advantages of using phantom stock as compared to the issuance of real shares (or options to purchase real shares). As to the employee, there is no cost or tax consequences to acquire the shares. In the case of real shares, the employee must either pay for the shares or he or she must eventually recognize income equal to their value. The second advantage, this one to the employer, is that a phantom stock plan is a compensation arrangement; even though based on the value of the Company, the payments made under the plan are deductible by the Company for tax purposes. By contrast, dividends paid on real shares and redemptions of real stock are made with "after-tax" dollars. Phantom stock and the associated rights can be virtually whatever the Company wants to make of them. The flexibility of such a plan as a means to reward loyal employees and to instill in them an "owner's mentality" makes such a plan a useful tool in maintaining a high quality, highly motivated staff. Please feel free to contact us if such a phantom stock plan is of interest. For more information contact Warren Vogel. Copyright 2002 by Silverman Bernheim & Vogel - All Rights Reserved. << Back to Article Index |
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