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Phantom Stock – A Better Way to Motivate Your Employees

By Generational Equity

08/31/2012

We regularly meet business owners who use a variety of methods to attract, retain, and motivate their employees.

One of the most common techniques we see is providing employees with company stock so that they feel like they have an ownership position in the business. The goal of this method of motivation is great, however, when it comes to the eventual sale of your company it comes with one huge downside: Your employees get to vote!

That’s right, every employee that has received even a single share of the stock in your company is required by law to vote and approve any ownership changes. Can you imagine how complicated this becomes? We do, because we see it all the time.

In fact we recently completed the evaluation of a company whose majority owner decided that, based on a variety of factors, now would be a great time to exit. When we created the engagement agreement, we had to point to him that the 17 minority shareholders, all current employees, would not only need to sign the agreement they would also need to be involved in approving the sale. Needless to say, he was not pleased to hear that information as he was keeping the potential sale completely confidential.

Fortunately, there is an alternative method you can use to give your employees the feel and pride of ownership without giving them voting rights.  

Phantom stock or phantom equity is a method that allows you to give your employees shares of non-voting stock which they can redeem later, usually when the company is sold or when the employee retires (assuming the employee is fully vested). And unlike traditional shares, that need to be repurchased when an employee leaves or is terminated, phantom shares “essentially disappear upon certain triggering events”.

There are also a number of tax advantages to both the employee and the company via the use of phantom stock. The most important is that a company can classify phantom stock as an expense and use it as a write off in the year given. 

Create an Exit Plan that Protects Your Interests

From our perspective as an M&A advisory firm to privately held companies, phantom stock is a more favorable method to use as an incentive to retain employees.  

It allows you to reward your key employees upon the sale of your company without being forced to disclose to them very early in the process that you are considering the sale of your business. Doing so would force you to deal with all the potential complications that may arise from that news.

Generational Equity does not provide tax and stock structure advice. Before you consider doing any sort of stock sharing plan, you need to consult with your CPA and attorney. But while talking with them, bring up the subject of phantom equity as an option. It is not widely known and has many benefits.  

If you would like to learn more about phantom equity, here are links to online sources on the topic for you:

The most important issue for you is this: be sure to grow your company with the end game in mind.  

The end game should take into account what you want to do with your business to maximize your eventual ROI (return on investment). Many of you will spend years and years building a great business. As you do so, be sure to consult with experts on the best ways to motivate and retain your employees that do not detrimentally impact you. 

Again, we do not propose to be experts in the appropriate corporate structure for you and your company. Talk to your CPA and attorney for that. We are skilled in helping business owners monetize their largest asset and find optimal buyers.  

If you are interested in eventually exiting your company and you have not developed an exit strategy, you need to attend one of Generational Equity’s M&A workshops. These are designed to help business owners learn more about their options regarding when and how to exit their companies for the most profit. 

And keep this in mind that the choices you make today regarding how to retain and motivate your employees could have a HUGE impact on you later when you decide to sell your business. Be sure to carefully weigh your options and talk to experts on these topics before taking the plunge and setting up any stock sharing program.

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