In a highly connected world, where your top performing employee is only a LinkedIn message or a Head Hunter’s call away from quitting his job and joining your direct competitor, it is no wonder that companies are going to great lengths to incentivise employees to stay with the company long term, by offering them a percentage ownership of the company under Share Option Schemes.
Share Option Schemes are a form of employee benefit scheme whereby employees acquire a specific number of shares in the company upon reaching specific targets, whether they be financial or based on years of service or some other KPIs. As they have become more popular, they have become very sophisticated, and as companies grow, they become increasingly difficult to manage. In most cases, a special class of shares is created within the company to cater for the employee share option shares (usually carrying no voting rights) as well as tag-along and drag-along provisions, provisions covering leavers and bad-leavers, and a myriad of other provisions, including all sorts of contingencies, such as the company deciding to go list on the stock exchange.
Enter: Phantom Share Option Schemes, where the employee does not receive actual shares in the company, and will not be registered in the company’s shareholders register, but will receive “Phantom Shares”, from the company, which will entitle him to receive the same value in cash, which he would have been entitled to as a dividend with “real” shares, in the form of a bonus.
In other words, the employee does not receive any equity in the company, does not become a shareholder, does not acquire any rights as a shareholder (to attend meetings or inspect books) and has no ties to the company, but will receive a cash payment in accordance with the terms of the Scheme, and which is usually tied to the company’s share value.
In most cases, and seeing as Phantom Share Option Schemes are a book keeping exercise, companies create a phantom shares account, where fictitious shares are created, and, when an employee joins the plan, shares are allocated in his favour.
Once a Phantom Share is allocated in favour of an employee, the employee becomes entitled to deferred compensation, proportionate to the number of shares received or earned, in the form of an annual bonus (instead of a dividend payment) equivalent to the market value of the company’s shares at that time, or the dividend payment he would have been entitled to, had he been registered as a shareholder.
In other words, the value of the Phantom Shares will rise and fall with the company’s shares, and the employee will be as invested in ensuring the company continues to grow and become profitable, as he would if he owned “real” shares.
On the other hand, the “phantom dividends”, which are not dividends at all, but are a bonus paid by the company to the employee, are taxable as ordinary income to the employees and are deductible to the company, an added benefit to the company over and above the benefit of keeping the administration of the company’s shares simple, keeping ownership of a family owned company within the family, and avoiding disputes with ex-employees and bad-leavers.
All in all, Phantom Share Option Schemes are a clever, no-frills alternative to the traditional Employee Share Option Scheme. They achieve the same results with lower risks and costs to the company, and as word about them spreads, they will become increasingly popular with employers.