An overview of phantom shares, how they work and their tax treatment.
Phantom shares are a form of stock compensation, but rather than issuing shares upfront, they’re an agreement to pay the recipient in the future.
But in actual fact, no shares are issued at all. Instead, the recipient receives a cash bonus equal to the value of the phantom shares at the time of payment.
Phantom shares will often have conditions attached to the agreement, typically fulfilled when milestones are achieved or if the business is sold.
Like all forms of conditional equity, phantom shares incentivise recipients to work towards achieving the business’ goals and reap the rewards later.
Each agreement will state how many phantom shares the recipient will receive, and the exercise price for each share.
However, the exercise price is never actually paid. Instead, the recipient receives value on the difference between the exercise price and the sale price.
An example agreement may look something like this: Employee X has been granted 1,000 phantom shares with an exercise price of £0.50 per share. They will earn the cash equivalent of 1,000 shares when the business is sold, less the exercise price.
Why do companies issue phantom shares?
As mentioned above, phantom shares are a form of compensation. But they’re much more flexible than simply paying cash bonuses, and attaching certain strings to the agreement gets everyone pulling in the same direction.
Attract and retain talent
Phantom shares are a great way to attract employees and motivate them to stick around and earn their bonuses.
As there isn’t really any criteria the company needs to meet (unlike EMI for example), companies of all shapes and sizes can issue phantom shares.
Plus, phantom shares can be issued to anyone, not just employees. So consultants, partners, and even other companies can receive phantom shares for their help in growing the business.
It’s also quite common for multinational companies to give overseas staff phantom shares, as the bonuses are subject to income tax at their usual rate.
Of course, the cash has to be readily available in order to pay cash bonuses. This might not always be possible for startups or even established companies, but phantom shares offer a way to use the equity in the company to reward people for their efforts.
… and equity
By issuing phantom shares instead of actual shares, companies can conserve their equity and prevent existing shareholders from dilution.
When the bonuses are paid, a proportion of the company’s share capital – or proceeds from the exit – is reserved for phantom share recipients.
What’s the tax treatment for phantom shares?
Phantom shares are treated as a cash bonus, so the recipient will be liable to pay income tax at their usual rate. But only once the bonus has been paid.
As nothing is actually received on issue of phantom shares – cash or equity – no tax liability is created on the initial award. All the recipient actually gets is the prospect of receiving a cash payment at some time in the future.
If a company is receiving phantom shares, they will book the bonus as revenue and be charged corporation tax at their local rate.
Can I issue phantom shares through Vestd?
Absolutely! This is currently a beta service, so please contact us if you’d like to issue phantom shares and we’ll help you get started.
We’ll also provide a phantom share agreement template for you to use, so there’s no need to get your lawyers to draft something new (though you may want them to review ours).
Once you’ve set the conditions of the phantom share scheme, you’ll add recipients and invite them to accept their award.
They’ll be prompted to join Vestd where they can view their shares and project their future value on their own dashboard.
Sound good? Get in touch to set up your phantom share scheme.
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