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 Plans.
Share Option Plans 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, Share Option Plans 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 Plan (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 sale of the company or the company deciding to go list on the stock exchange.
Enter: “Phantom Share Plans”, 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 had he held “real” shares in the company, in the form of a bonus (as opposed to a dividend payment).
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 Plan and the value of the company’s shares.
In most cases, since Phantom Share Plans are a book keeping exercise, companies create a phantom shares account, where fictitious shares are created, and, when an employee joins the Plan, and an agreement regulating the Share Option Plan is concluded, the phantom 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 a bonus (paid every time a dividend is paid to the shareholders or as an annual bonus or on a trigger event such as the sale of the company or any other trigger event which may be desirable) which bonus would be equivalent to the market value of the company’s shares at that time, or, the dividend payment the employee 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 share value, 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.
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 Plans are a clever, no-frills alternative to the traditional Employee Share Option Plans. 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.
About the Author
This article was authored by Dr Davinia Cutajar, Managing Partner, CSB Legal. Davinia was conferred a Doctorate of Laws from the University of Malta in 2005 and admitted to the Malta Bar in March 2006. She is a member of the Chamber of Advocates and the Institute for Financial Services Practitioners (IFSP), contributing most actively through her contributions within the IFSP’s sub-committee on compliance. Her main areas of practice are: Company Law, Trusts and Foundations, Compliance Law, Corporate Governance, Civil and Commercial Litigation, Contract Law and Real Estate Law.