According to a 2019 WorldatWork survey of private companies, 2019 Incentive Pay Practices: Privately Held Companies 6th Edition, the prevalence of private companies using long term incentives has been increasing over time. Discover what makes RSM the first choice advisor to middle market leaders, globally. Should participants receive the base value of the phantom stock units, or only participate in growth over and above the base value? Upon the sale of the company, the executive would have the same $100,000 capital gain. Implementing phantom stock pros the company in terms of its human resource in two ways: The employees work with renewed enthusiasm which leads to an increase in overall productivity. A nonqualified deferred compensation plan that violates Sec. The . 181 0 obj <>stream Phantom Stock Plan Accounting | Pittsburgh Audit Firm 2. This can include customizing grant and vesting schedules, incorporating performance-based features, or creating hybrid plans. We welcome your call for any follow-on questions about the Phantom Stock Plan Modeler. 0000085139 00000 n Having a well drafted plan charter is imperative for companies. A company may wish that former employees do not own company stock after they separate from service. However, unlike Bob's phantom shares, Mary's are worth the full value which means she's paid out the full $85.25 per share and gets a bonus of $42,625. How broadly or narrowly should the plan define what qualifies as cause for termination? The charter also states voting rights, if any. SARs are a form of bonus compensation given to employees that is equal to the appreciation of company stock over an established time period. Corporate Law Client Advisory: Demystifying Phantom Stock Plans - How To check the background of any investment professional associated with EBS, useFINRAs BrokerCheckwebsite. As with phantom stock, this is normally paid out in cash, but it could be paid in shares. Cash-based performance awards are most prevalent (65% of survey respondents), followed by real equity (36%), non-qualified deferred compensation plans (21%) and phantom equity (15%). SARs don't offer dividend-equivalent payments. Generally, under these structures, at the time of sale the plan triggers a payout to the executive that is taxed as compensation when paid. However, there is one key difference between the two plans. Visit rsmus.com/about for more information regarding RSM US LLP and RSM International. For example, you should always be aware of how any plan youre participating in is going to be taxed when you receive a benefit. For now, let's take a deeper look at how phantom stock works. The value may be a specified value, determined by an express written formula or determined by a third-party appraisal. Business considerations include the following: How vital is the employee to the organization's mission? Phantom Stock Plans in Privately Held Businesses For example, if the issuing price of the phantom shares is $50 and the companys share price at redemption is $20, the plan participant would not reap any benefits. Executive Benefits Solutions and LSF are not affiliated. Using the previous example, the stock price was $5 on January 1 and $30 on June 1. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Phantom Stocks: Equity Compensation with Flexbility - Gordon Law Group 409A because the program is not covered by that Code section. Even though it's not real, the phantom stock follows the price movement of the company's actual stock, paying out any resulting profits. To illustrate the issue, consider the following: Example: The value of the company allocated to the executive's program at the inception of the program is $10,000, its value at the date of conversion to actual ownership is $100,000, and the value of the ownership interest at the time of sale is $200,000. 0000082447 00000 n Review these steps along with the tools, wiki and videos to get a start on your perfect plan. However, they have significant financial and tax ramifications that can take you unawares. 0000082189 00000 n schedule. Representatives may only conduct business with residents of the states and jurisdictions in which they are properly registered. It provides increased incentives as the value of the company increases. The phantom stock plan should indicate the number of phantom stock units or the participation percentage interest to be granted to the employee. The main difference between SARs and phantom shares is that phantom shares have the possibility of offering dividend-equivalent payments. On June 1, your employers stock price is $25 higher than on January 1. Afinancial advisorcan help you make the most of your bonus pay and optimize your taxes. 0000084333 00000 n The plan must be properly vetted by an attorney, with all of the pertinent details specified in writing. The charter also states voting rights, if any. 0000083355 00000 n Parameters and Trading, With Examples, What Is a Depositary Receipt (DR)? Phantom Stock Plans - Schiff Benefits Group, LLC In general terms, phantom stock is a compensation plan that confers the right to receive cash at a future point in time, typically a share of the proceeds received upon the sale of a company. 0000066328 00000 n For company owners, phantom stock can help grow their business offering top employees a reason to stay and help the company succeed for the long-term. Anthony Bakale, CPA, is with Cohen & Company Ltd. in Cleveland. 0000004947 00000 n In order to receive the benefit of these shares, Bob needs to stay with the company for five years. Phantom stock qualifies as a deferred compensation plan. Phantom stock can be provided to every employee, either across the board or distributed variably depending on performance, seniority, or other factors. They might decide to create a phantom unit plan that has a value of $10 per unit. The plan does not consist of genuine shares in the business, but it confers similar financial benefits to employees. Having a well drafted plan charter is imperative for companies. Instead, they receive anything above and beyond what the phantom stock was worth when it was granted. Lion Street Financial https://lionstreet.com/wp-content/uploads/2021/05/Lion-Street-Financial-Form-CRS.pdf, Executive Benefit Planning for Privately Held Companies, https://lionstreet.com/wp-content/uploads/2021/05/Lion-Street-Financial-Form-CRS.pdf. Should the phantom stock units pending payment continue to participate in the growth in value of the company? Once you've considered the answer to these questions, you should have a better idea of whether a phantom stock program would benefit your company. You can simply give Sally some stock. While phantom stock plans and stock option plans compensate employees based on stock price, they diverge on one primary point. Find out whether your company is ready for a plan. Gordon Scott has been an active investor and technical analyst or 20+ years. Phantom Stock Plans | Definition, Types, Features, Pros, & Cons Everything You Need To Know About Phantom Stocks - Vantage Circle HR Blog How should a change in control be defined? The tools in this section of the website can help you discover important information about how to use phantom stock to grow your company. Stock Appreciation Rights (SARs) are a form of phantom stock. For companies that implement phantom stock plans, there remain important considerations. For example, say you enrolled in a phantom stock plan on January 1 with a payout date of June 1. Under a stock grant or SAR, the general concept is that the executive will be rewarded by the increase in value of the ownership shares allocated at the date of the company sale over the value on the date they were issued. Phantom stock might not always be your best option. How Do Phantom Stock Plans Work? | Greenbush Financial Group How to Choose an Employee Stock Plan for a Closely Held Company Companies can choose what the triggers areexamples include a separation from service, a change in control, or a specified future date or fixed payment schedule. document.getElementById( "ak_js_1" ).setAttribute( "value", ( new Date() ).getTime() ); Susan brings over 25 years in consulting and leadership positions in compensation and human resources to her clients. Other questions that are to be answered in the design of a long-term incentive plan that is based on phantom stock include: Phantom stock is often a very attractive alternative to providing higher salaries or bonuses to support the firms ability to attract and retain the senior leadership team. hb```b`` @Q20 oY(,U. In other cases, valuation may be required periodically, such as annually, or on a specific future date. Incentivize hard work and loyalty by tying senior-level employees compensation to company performance. 1.409A-1(b)(4)(i)(B), and thus is a prohibited acceleration, as a change of control has not occurred. Acton, MA 01720, Tel: 978-371-0476 0000003010 00000 n The issuing price of phantom shares in a phantom stock plan is set by the company and not necessarily tied to the value of the companys stock at that time. With that said, the company typically follows a valuation policy for the issuing price of phantom shares. Therefore, a response to a request for information may be delayed until appropriate registration is obtained or exemption from registration is determined. Phantom Stock: Everything You Need to Know - UpCounsel Learn more about how they work. The phantom values are determined based upon a formula in the plan, which happens to track closely to the actual value of the share price. An author, teacher & investing expert with nearly two decades experience as an investment portfolio manager and chief financial officer for a real estate holding company. Diversification does not guarantee a profit or protect against a loss. These features motivate senior-level staff but require companies to have cash on hand for plan payouts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. %PDF-1.7 % 0000032434 00000 n 0000065543 00000 n Phantom stock may behypothetical, however, it stillcan pay out dividends and it experiences price changes just like its real counterpart. The purpose of this 2011 Phantom Stock Option Plan (the "Plan") is to aid Fuel Systems Solutions, Inc., a Delaware corporation (the "Company"), in attracting, retaining, motivating and rewarding officers and key employees of the Company or its Subsidiaries to promote the creation of long-term value for shareholders by closely aligning the . Read ourprivacy policyto learn more. Phantom stock, also known as synthetic equity, has no inherent requirements or restrictions regarding its use, allowing the organization to use it however it chooses. Each phantom stock plan has a plan charter. Without the existence of real equity, phantom equity can track to the value of the business, either done by a formal valuation of the company or as a multiple of earnings, such as a three-year weight average of EBITDA times a market multiple. The cash payment per phantom stock would be $20. It is an employee benefit that gives employees the opportunity to purchase company shares at a predetermined price, known as the "equity value." Employers must have sufficient cash to pay employees when the plan matures. 409A was enacted in reaction to the actions of executives of some public companies that went bankrupt during the recession and stock market crash in the early 2000s. Here are answers to nine frequently asked questions about phantom stock plans and what they could mean for your company. 83(b) election was not made. Financial Modeling & Valuation Analyst (FMVA), Commercial Banking & Credit Analyst (CBCA), Capital Markets & Securities Analyst (CMSA), Certified Business Intelligence & Data Analyst (BIDA), Financial Planning & Wealth Management (FPWM). If you are interested in how to make a plan work well for your organization, and realize the powerful benefits of these plans, contact Wilson Group. A phantom stock program must meet the requirements set forth by the Internal Revenue Service (IRS) code 409(a). Sometimes awarding phantom stock, especially if given to a large percentage of employees, may be seen as a non-qualified plan under ERISA. In the example, the issuance of ownership is includible in the executive's taxable income under Sec. Let's imagine that in four years the value of those shares is 5 per share at the execution moment. More formally, this is called a Restricted Stock Grant (or one of its variations). For example, a company can set the issuing price of their phantom shares at $10, $20, or $30 without regard to its share price at the time. Photo credit: iStock.com/whitebalance.oatt, iStock.com/fizkes, iStock.com/ridvan_celik. While a higher salary and company car has obvious uses, obscure rewards like phantom stock plans can be murkier. Consequently, these plans can be simple, but they should not be simplistic. Will any funding mechanism be used to help the company meet fund its future obligations to pay the amount owed to recipients? You may also benefit from working with a financial advisor who can help you analyze how a phantom stock plan might impact your personal finances. Equity grants may give rise to voting rights or unforeseen minority rights under state law. Its also called a shadow stock plan because its value mirrors a companys stock. Similar to real equity, as the company can use an option-type unit (where the value is based on the gain in stock price) or full value-type unit (that has a value to start with). Phantom stock plans are versatile compensation tools companies can use to reward employees without impacting shareholder status. For example, if real share price is valued at $10 per share one year and $12 per share the next year, then phantom stock value reflects the same two values. When setting up a phantom stock plan, Section 409A must be followed, which includes the guidelines for distributions and terms of the plan. If payments should be made in installments, over how many years? 409A. 0000004083 00000 n Then, lets say that the value of the enterprise has grown to $30,000,000 in 5 years, each unit is now worth $15 (or $30,000,000 divided by 2,000,000). Usually, the award is for a specific number of units, or phantom shares, that follow the price of the company's actual shares going up as the company is worth more and down as it's worth less. startxref Stock option grants are excluded, provided the exercise price at the time of grant is not less than the fair market value (FMV) and the number of shares subject to the option is fixed. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: Within the finance and banking industry, no one size fits all. Ask our Investing expert. 0000065825 00000 n Employees only receive compensation if they stay with the company or hit job performance goals. In addition, employers can subtract taxes from payouts on the employees behalf, streamlining tax calculations for everyone involved. Actual payouts of the phantom stock units are usually deferred until a predetermined future date or until the employment relationship is terminated due to retirement, death, or disability. Sec. For example, the company could grant the employee a 5% interest initially and increase the interest to 10% after the employee completes five years of service. Securities offered through Lion Street Financial, LLC (LSF), member FINRA, SIPC. Build A Plan Get Started Here's where you can learn and follow the steps used by professional consultants to design and implement effective phantom stock plans. Organizations like to use phantom equity when they want key employees to have skin in the game but real equity is not available, or the owners do not want to dilute real equity or share ownership. 0000130042 00000 n This site is published for residents of the United States only. Phantom stock is used by companies as an approach to long-term incentive plans and as a mechanism for creating additional performance-based awards. Before looking into this situation, it is necessary to give a brief overview of Sec. Association of International Certified Professional Accountants. Updated on March 9, 2022 Reviewed by Charlene Rhinehart In This Article Definition and Example of Phantom Stock How Phantom Stock Works Types of Phantom Stock Pros and Cons of Phantom Stock Photo: Morsa Images / Getty Images Definition Phantom stock is offered by some companies to their senior employees. In March, the common share price of Company A is $70. Conversely, full-value plans pay employees according to the companys stock price. 409A, the plan must be in writing, and distributions from the plan cannot be accelerated and can be made only on account of the following events: The conversion of a phantom stock interest to actual ownership represents one of the many Sec. What percentage of the companys value should be dedicated or reserved for this plan? Instead of receiving the $25 increase, employees with full-value plans would receive $30 per phantom share on June 1. One-Time Checkup with a Financial Advisor, 7 Mistakes You'll Make When Hiring a Financial Advisor, Take This Free Quiz to Get Matched With Qualified Financial Advisors, Compare Up to 3 Financial Advisors Near You. Even if the formula provides a value identical to the stock's value, it is not considered a SAR, as its benefit is based upon the phantom stock agreement, not the stock's value. However, they also have volatile income tax implications. Both reward employees differently using a companys stock price. This can, in turn, result in higher selling prices for a business if a prospective buyerperceives the upper management team as being stable. Employee stock ownership plans (ESOP) and 401(k) plans are qualified plans that are considered legal under ERISA. It emphasizes the growth in the value of the business tied to the price of their phantom units. Cookies collect information about your preferences and your devices and are used to make the site work as you expect it to, to understand how you interact with the site, and to show advertisements that are targeted to your interests. A pension plan is an employee benefit that commits the employer to make regular payments to the employee in retirement. If the issuing phantom stock price is $30, and the companys share price at redemption is $100, the cash payment per phantom stock would be capped at $50 $30 = $20. Both types of plans resemble traditional nonqualified plans in many respects, as they can be discriminatory in nature and are also typically subject to a substantial risk offorfeiturethat ends when the benefit is actually paid to the employee, at which time the employee recognizes income for the amount paid and the employer can take adeduction. Form and Structure of Phantom Stock Agreements, Reasons to Consider Not Using Phantom Stock Plans, Phantom stock is not a good idea if the company is planning on issuing it to most or all employees, especially if the phantom shares will be paid out when the employee leaves the company or retires.