Current economic indicators show that the United States is emerging from the recession. Can you feel it? Has your company rebounded and returned to its pre-recession sales and profitability levels? Do you have stores of excess cash and nowhere to spend it? If so, congratulations. Write some checks to your employees as thanks for their hard work and dedication and ignore the rest of this article. But, if your company, like most other U.S. businesses, continues to struggle financially and is looking for creative ways to incentivize key employees.
Current Economic Environment
The reports do not lie. The economy is rebounding. While this does indicate positive signs for your company’s future, it also means that opportunities are not as limited for your employees as they may have been twelve months ago. Human capital is essential to every organization: it is damaging to lose key employees and costly to replace them. In many situations, employees may not want to leave your company, though they may feel compelled to do so because another compensation package is too good to pass. In the recovery phase after a recession, with limited access to cash, what can you offer to your key employees in the form of compensation that will incentivize them to become invested in the growth of the company, while limiting your company’s cash requirements until it has had a chance to fully recover? The answer may come in the form of a phantom stock plan.
Phantom Stock Plan Defined
Phantom stock, much like an actual equity investment in a company, increases in value as the value of the underlying investment increases: in this case, your company. The primary difference, however, is that no actual ownership is given to the participant in the phantom stock plan. Under a phantom stock plan, a key employee (or multiple key employees) is offered a theoretical block of stock valued at a certain price per share. At a subsequent date defined within the phantom stock agreement (e.g. employee’s termination date, company sale date), the employee’s phantom stock is revalued based upon an appraisal of the company. The value built into the employee’s phantom shares is then repurchased by the company, thereby compensating the employee and relieving the company of its liability. Notice that no actual ownership interest transfers in the event of a phantom stock plan; the employee is not entitled to typical owner rights, such as the election of shareholders, receipt of dividends, or guaranteed participation in high-level managerial decisions.
Phantom Stock Example
A mid-size manufacturing company has been hit particularly hard by the recession of 2008 and 2009, though it has experienced signs of life in the form of an increased backlog of orders, and minimal capital infusions required from its owners. Instrumental in seeing the company through its darkest days, the CFO has been presented with several offers for employment from her current employer’s main competitors. Though she has expressed a deep respect for her current employer, and does not truly wish to leave, she believes she may be selling herself short given the current offers presented to her. Her current employer understands that he risks losing a key employee, though cash is still too tight to offer a raise or a bonus. The employer requests an appraisal of the company that shows the approximate value to be around $10 per share. In order to incentivize his CFO to become invested in the long-term growth of the company, he offers her 1,000 shares of phantom stock to be redeemed at the time of her retirement. Several years later, upon her retirement, the company appraises at $35 per share. The owner repurchases the shares of phantom stock for $25,000 ($35 – $10 x 1,000 shares). The employer was able to compensate his key employee CFO while deferring the cash outlay required until the company was more financially stable.
Phantom Stock is Different From Stock Options
Stock option plans give participants the right to purchase a certain number of shares of your company’s stock at a predetermined price. Similarly to phantom stock plans, stock options become valuable to the participants when the value of the company increases. Both offer a long term incentive to participants to become vested in the sustained growth of the company. Stock options, however, involve an actual transfer of an ownership interest to the participant. Most companies that offer stock options to key employees have shares that are publicly traded on open markets, or will soon offer shares publicly.
Is Phantom Stock the Answer for Your Company?
You know your company and your employees better than anyone else. If certain key individuals are instrumental to the continued success of the company, and you wish to offer them an incentive that defers the cash constraints of additional compensation, perhaps a phantom stock plan provides the answer. As with any incentive plan, there are many facets to consider in structuring the plan legally and achieving the desired results. If you are interested in exploring the options available through phantom stock plans, we would be happy to talk to you.