America’s labor shortage is approaching epidemic proportions. Across the country, more jobs are available than workers to fill them. The unemployment rate has dropped to a nearly two-decade low. Businesses are complaining of worker shortages, arguing they could do more, sell more and build more if they could just find skilled employees.
According to the Department of Labor, at the end of January 2019, the U.S. economy had 7.6 million unfilled jobs, but only 6.5 million people who looking for work. It was the 11th straight month the number of job openings was higher than the number of job seekers. This shortage has translated into higher wages to retain and attract workers, which increases employers’ costs of doing business.
What can a business do to attract and keep skilled employees? In addition to paying competitive wages, many business owners are considering adding retention and performance programs for their most valuable employees. One such program is called a Phantom Stock Plan.
What is Phantom Stock?
A phantom stock program is a form of long-term incentives used by businesses to award employees for improved company value without actually giving away equity. As a result, no dilution occurs for shareholders. It is a type of deferred bonus offered to key employees, where the future payout is tied to appreciation in the equity or market value of the sponsoring company. The term “phantom stock” may be used broadly or narrowly since no formal or statutory definition of the term exists.
Some companies use the term phantom stock to denote any type of plan for which employees must wait until a future date to receive the promised financial value. More narrowly it indicates a plan that is intended to mirror restricted stock awards or stock option grants. In this usage, the sponsoring company creates certain units or “phantom shares” that may resemble actual stock. But actually, it is a commitment to pay the employees cash upon fulfillment of certain conditions such as duration of employment or growth in company value or both.
Phantom stock may also be known by such terms as phantom shares, simulated stock, shadow stock or synthetic equity. Participants in phantom stock plans are expected to view the company’s objectives through the same lens as the shareholders. These types of plans can help attract employees and retain and differentiate a company’s value proposition from its competition. Phantom shares do not result in owner equity dilution because actual stock is not being transferred to the participant.
Phantom Stock Plan: Why?
Seven good reasons to consider a Phantom Stock Plan
- Phantom stock helps align goals between business owners and their key employees for growing the business. Most owners want great talent that thinks like an owner and can execute a business plan. If a company is
focused on growth, employees are the most critical assets for this growth objective. - Phantom stock helps create value by turning other long-term incentive plans into growth drivers.
- Phantom stock helps a company compete for employees who have the ability to be growth catalysts for businesses.
- Phantom stock plans can retain employees because employees must wait until a future date to receive the financial value of a promise given today.
- Phantom stock plans demonstrate fairness because they share value with those who help create it by protecting both the shareholder and the employee interests.
- Phantom stock plans are linked to the same business objectives as the owners.
- Phantom stock plans form long-term incentives used by businesses to award employees for improved company value. As a result, it is a type of deferred bonus where the future payout is tied to appreciation of the equity, or market value of the sponsoring company.
The term “phantom stock” may be used broadly or narrowly since there is no formal or statutory definition of the term. More narrowly it indicates a plan that is intended to mirror restricted stock awards, stock appreciate rights (SARs) or stock option grants. In this usage, the sponsoring company creates certain units or “phantom shares” that may resemble actual stock but are actually a commitment to pay the employees cash upon fulfillment of certain conditions such as duration of employment or growth goals of the company.
Types of Plans
In general terms, three types of phantom stock arrangements are available. They are not mutually exclusive; a company could have just one type or all three depending on its objectives.
For example, assume an employee receives 100 phantom shares with a starting price of $10. At a pre-determined future date, the company will calculate the value of the phantom stock and pay the employee the full value. Let’s assume that the share price appreciates to $18. The company will pay the employee $1,800 as a cash distribution. This $1,800 reward is taxed at ordinary income rates.
2. Performance Phantom Share Plan is a type of plan contains two distinct performance-based elements. First, employees must achieve certain pre-determined performance targets. If they do, they are awarded phantom shares. The number of shares may vary by employee and by the degree to which the targets were achieved. Financial targets might include such measures as Pre-tax Income, EBIT or EBITDA.
The second, performance element relates to the potential improvement in value that may come through phantom stock value appreciation. Once awarded, the phantom shares may still be subject to vesting schedules or other restrictions. The tax effect to employees is identical to that of full value phantom stock.
For example, let’s assume an employee receives 100 phantom stock options (PSOs) with a starting price of $10. At a pre-determined future date, the company will calculate the value of the phantom stock price and pay the employee any positive difference between the original price and the appreciated price. Assume the share price grows to $18 from $10. The company will pay the employee $800 (the increased value).
3. A Phantom Stock Option Plan, also known as a Stock Appreciation Rights (SARs) plan, is a deferred cash bonus program that creates a similar result as a stock option plan. As with the previous two plans, the sponsoring company determines a phantom stock price through an internal or external valuation of the company. Employees are awarded some number of phantom options that carry specific terms and conditions. Should the company phantom stock appreciate over time, employees will receive a cash payment equaling the difference between the original price and the appreciated price.
Most business owners and CEOs intrinsically understand the principle, “the more value you help create, the more reward you will receive”. They know that sharing value through long-term incentive plans is essential to capturing the loyalty and commitment of top achievers.
Fairness might best be summarized as follows: Successful companies share long-term value with high performers because it builds trust and confidence between ownership and its employees.
Regardless of which plan(s) are chosen, employers have the opportunity to eliminate or greatly reduce employee turnover among key personnel. The cost of adding these plans are minimal at best. The increase in performance and longevity of employees is self- liquidating when the cost of employee turnover and the increased profits and value added from incremental growth are analyzed.
Gary Miller ([email protected]) is the CEO of GEM Strategy Management Inc., an M&A consulting firm advising middle-market private business owners. Read more of Miller’s blogs here.
