How employees can benefit from company growth without holding shares

What are Phantom Share Schemes, and why are they of interest for a company?

Phantom Share Schemes are set up by companies to provide their employees with financial exposure to the increase in the share price of their employer, without giving them actual shares or options in the company.

There are generally two types of Phantom Share Schemes: one where employees receive a cash payment equal to the value of a real share in the company, and another where they are given the right to receive a cash payment equal to the growth in value of the company’s share above a notional exercise price.  The former is a phantom share, and the latter is a phantom share option.

There are several commercial reasons why a company may want to use a Phantom Share Scheme, rather than a more traditional employee share option plan (ESOP), including:

• restrictions on the issue of new shares, such as following an investment round or in a joint venture where shareholdings have been carefully agreed;
• keeping a company’s cap table simple;
• giving employees an incentive to support the company’s share price, without the added complexity of having them as shareholders;
• retaining control over the valuation of the phantom share/option, for example, to reflect a pre-money valuation so that the upside is calculated on the contribution from the employee’s work rather than outside capital investment; or
• offering more flexibility, by, in particular, a phantom share option, as such schemes do not necessarily rely on an exit event to be exercised, and, in this era of companies staying private for longer, they can incentivise employees with fewer limitations on payouts.

What are the downsides of a Phantom Share Scheme compared to an ESOP?

Phantom Share Schemes do have limitations, so they may not be best for some companies:

• Phantom shares are synthetic, so they do not offer the same sense of ownership that an actual share does, which can mean that the holder of a phantom share does not feel as engaged with the company as with an actual option or shareholding.
• The flexibility of exercising a phantom share option can mean that employees are able to exercise it when they see a substantial gain, regardless of the longer-term position of the company or the company’s working capital ability to pay out under the scheme.
• Phantom share options may be more expensive for a company than normal share options because it is easier for an employee to exercise them and therefore receive payment, whereas normal share options are more likely to lapse and not require payment.
• ESOPs have tax advantages which do not apply to a Phantom Share Scheme, including that employees are able to exercise options without paying income tax and the employer is not liable to National Insurance contributions (provided the conditions are met).
• If the company is concerned about cash flow, then an ESOP would be preferable, as those share options are settled with shares, whereas a phantom share option is only settled with cash.

Is a Phantom Share Scheme right for my company?

Phantom Share Schemes are a great tool for an early-stage company that wants to align its employees’ incentives with the company’s.  They can give the employee a stake in the company’s future, with real monetary benefits, whilst retaining a streamlined cap table.

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Are you thinking about how you can align the incentives of your employees with your company?  Our Corporate & Commercial team would be happy to explore options with you, including an ESOP or Phantom Share Scheme. Get in touch to start the conversation.