{"id":5067,"date":"2022-05-02T15:43:41","date_gmt":"2022-05-02T10:13:41","guid":{"rendered":"https:\/\/www.trica.co\/equity\/blog\/?p=5067"},"modified":"2022-07-01T04:27:05","modified_gmt":"2022-07-01T04:27:05","slug":"phantom-equity-different-true","status":"publish","type":"post","link":"https:\/\/trica.co\/equity\/blog\/us\/phantom-equity-different-true\/","title":{"rendered":"Phantom Equity: How Is It Different From True Equity"},"content":{"rendered":"

Equity is now a commonplace form of compensation, and it is vital in ensuring employee retention. However, the particulars of equity distribution plans can vary in how and when shares are allocated.
\nTrue equity always entails the actual transfer of stock ownership to an employee. Contrastingly, phantom equity is the flip side of such true equity distributions.<\/b> We detail exactly what phantom equity is, how it works, and why companies choose to employ it as a compensatory tool.<\/p>\n

What Is Phantom Equity and How Is It Different From True Equity?<\/b><\/h2>\n

As we hinted above, phantom equity is the \u2018shadow\u2019 side of true equity. This means that no stock is distributed in phantom equity distribution plans.\u00a0<\/b>
\nSelect employees (usually high-level) receive \u2018mock stock.\u2019 This entails receiving the benefits of stock ownership but no real company stock. Phantom stock is essentially a simulation of stock distribution that protects equity from further dilution<\/b> but allows employees to gain from company share growth financially.
\nPhantom stock units mimic the price movements of real stock units and will pay out any resulting profits in the same way real stock would.
\nYou may also be interested in: <\/b>How Transparency in Cap Tables Can Benefit Your Startup<\/b><\/a>
\nHow Does Phantom Equity Work?<\/b>
\nNow that we understand that phantom equity doesn\u2019t involve issuing real stock let\u2019s delve into how phantom equity distribution plans work.
\nEven though the phantom stock is an abstract concept, it still holds financial value like its real counterpart.<\/b> This cash value will be paid out to qualifying employees once the requisite waiting period is over (usually two to five years). Phantom stocks can be awarded in two ways, which we detail below:<\/p>\n

Appreciation only plan<\/b><\/h3>\n

Appreciation-only stocks bar recipients from receiving the full value of a phantom stock when it is cashed out. Instead, recipients receive only the \u2018profit\u2019 or appreciation value of the stock. <\/b>This is essentially the difference between the stock’s current value and the value of the stock when granted.
\nFor instance, let\u2019s say that Jane Doe was granted 1000 phantom shares in July 2020, when they were worth $40. To receive the cash value of these shares, Jane must remain at the company for three years.
\nAssuming that Jane stays with the company until July 2023, when the shares are worth $60 each, Jane will receive $20,000 ($20 appreciation earned per share, for 1000 shares).<\/p>\n

Full value plan<\/b><\/h3>\n

Full value phantom share plans payout recipients the entire worth of the shares at their current price.<\/b> This means initial phantom share value plus any stock appreciation.
\nFor instance, let\u2019s say that John Doe was granted 1000 phantom shares in July 2020, when they were worth $40. To receive the cash value of these shares, John must remain at the company for three years. Assuming that John stays with the company until July 2023, when the shares are worth $60 each, John will receive $60,000 ($60 per share, for 1000 shares).<\/p>\n

Advantages and Disadvantages<\/b><\/h3>\n

Phantom equity plans have proven very advantageous to businesses that wish to incentivize employees to stay with the company<\/b> without transferring any more ownership away from founders.
\nThis allows retention of power<\/b> since employees hold no voting rights. As a result, phantom stocks afford companies a greater level of flexibility than true equity distribution plans, but that\u2019s not to say there are no disadvantages to it.
\nIn fact, companies can incur significant costs in implementing phantom equity distribution plans. Higher outgoing cash flows are due to conducting necessary external equity valuations<\/b> and the cash payout for phantom stock.\u00a0<\/b>
\nTo avoid cash depletion, companies can circumvent this problem with a \u2018conversion clause\u2019 that converts phantom stock to real stock at payout.<\/p>\n

Which Companies Should Consider a Phantom Equity Plan?<\/b><\/h2>\n

Deciding on an equity distribution plan is one of any business’s core decisions. There are many things to consider, but phantom equity comes with a few extra considerations, which we detail below:<\/p>\n