Participation programs offer excellent opportunities to motivate employees and attract them to the company. The allocation of phantom shares can be an alternative to the distribution of "real" shares.
Attracting and retaining talent in the company
Especially in dynamically developing companies, the allocation of employee shares is often a very important method of attracting talent and retaining these people in the company in the long term. Participation programs can be designed in such a way that employees receive shares for the provision of labor services and thus participate in periodic profit payments and/or sell their shares at market value in the event of a sale of the company.
The disadvantage of the participation programs mentioned above is that a company's shareholder base is periodically expanded by a large number of small shareholders, which increases the administrative burden and makes it difficult to control the company's shareholding structure. In addition, certain rights are associated with the position of a shareholder (e.g. the right to information and control). In addition, in such a situation, it should be ensured that individual small shareholders cannot prevent the sale of the entire enterprise to a third party interested in such a transaction. Particularly in the event of redundancies, it should be possible to buy back shares that have already been allocated.
The phantom stock program is an extremely effective way to enable employees to economically participate in the long-term success of the company, but in such a way as not to grant them real shareholder status. The idea of a phantom share boils down to the fact that it is a virtual share in a given company, which reflects the value of a standard share and puts the beneficiary (partially) on an equal footing with the shareholder, in particular in terms of financial rights. With this in mind, the beneficiary of this arrangement usually receives payments corresponding to the realities of the dividend payout or realized capital gains at the time of exit. It is standard practice for the company's management to define all the parameters of the phantom shares through the Phantom Stock Plan (PSP).
Basic provisions of the phantom share plan
- Maximum number and terms of distribution of phantom shares: It is customary for the management of a particular company to allocate phantom shares where possible at its discretion and to grant mandatory entitlements to beneficiaries only as part of the actual allocation based on individual phantom share agreements.
- Vesting terms/dates: In order to ensure long-term transparency and a sense of trust, phantom shares allocated are vested for a specific period of time, which is specified in the contract, with unacquired phantom shares expiring upon termination of the employment contract.
- Dividend Equivalent Rights: The Board of Directors of a company has the discretion to decide in what proportion the dividend equivalent paid by the company should be distributed to all eligible phantom shareholders.
- Definition of liquidity events (sale, IPO, etc.): In market practice, the realization of a share in the value of a particular company takes place through fair settlement of phantom shareholders for their phantom shares according to the sale value or market value, with the Management Board each time specifying such parameters as time, and the mechanism for implementing such an exit.
Advantages compared to classic participation programs
- Sole power of the Board of Directors: The issue of phantom shares does not, in essence, require a resolution of the General Meeting or the involvement of a notary public. In addition, such an event does not require an amendment to the articles of association or an appropriate entry in the commercial register.
- Beneficiaries only receive asset rights: Granting profit rights to employees as part of the issue of phantom shares has no impact on the shareholder structure. As a consequence, it facilitates the handling of general meetings, and in the case of the sale of a company to a potential buyer, a clear structure of persons to whom the company is liable can be shown.
- Tax Consequences on Disbursement Only: Although the beneficiaries must pay tax on the gains from the exercise of the phantom share rights, they are not required to pay tax on them until the profits from the phantom shares are actually distributed. It follows that the allocation of phantom shares does not involve any tax consequences for the entitled persons. Ultimately, when profits are realized, there is obviously sufficient liquidity available to pay the tax liabilities.
Design/operating obstacles
Labor law: The applicable conditions of the labor market show that the allocation of phantom shares should not take the form of a variable remuneration component, but only a gratification ("bonus").
Termination: the termination of employees from performing labor services in the company and the forfeiture of phantom shares must be clearly regulated.
Accruals: Accumulated claims of beneficiaries entitled to exercise rights from phantom shares must be recorded by companies in the balance sheet and disclosed to the buyer in the event of a possible sale of the company.
The Eberhard Advisory team from the start-up department will be happy to advise you on all questions regarding the introduction of phantom shares.
