These days, top executive candidates
seek more from potential employers
than a salary and bonus.
“In today’s work force, it is extremely difficult to find and retain top executive talent,”
says Tyler Ridgeway, director of the Human
Capital Resources Group at Kreischer Miller,
Horsham, Pa. “As a business owner, you
must ask, ‘How can I make it more attractive
to work here without risking the financial
success of my company?’”
Phantom stock is an alternative vehicle to
traditional stock options, restricted stock or
similar deferred compensation programs.
The monetary incentive is real, and it’s a key
retention tool for midsize companies.
Smart Business discussed with Ridgeway
how phantom stock works and when these
plans are a smart fit for a business.
What is phantom stock, and what employer
might offer this benefit?
Phantom stock is a benefit plan that gives
selected employees, usually senior management, the advantages of stock ownership
without actually giving them company stock.
The employee receives ‘fake’ stock that mimics the price movement of the company’s
actual stock. The employee earns a bonus
equal to the increased value of the company’s
shares, but the employer does not have to
pay out stock. The plan works like this: Say
you decide to reward your top-performing
CFO with a phantom stock plan. You implement a plan that promises to pay the CFO a
bonus every five years that is equal to the
increase of the equity of your company. As an
owner, you retain the value of your company
and please shareholders by not diluting their
ownership rights. Remember, you’re not
transferring actual stock to reward your
CFO. You’re paying a cash bonus that is
equivalent to the stock value increase.
Phantom stock is treated as ordinary income,
like any other cash bonus.
What advantages do employers enjoy by
offering phantom stock as an incentive?
While large and publicly owned companies
offer benefits, such as stock options, medium-sized businesses are not necessarily able
to offer options. This may be because of prohibitive regulatory requirements or burdensome implementation costs. Either way,
some businesses seek an alternative to traditional benefits — they still want to offer an
incentive to recruit and retain top executives.
Perhaps this describes your business. You
see that there are employees who are critical
to your operation: a CFO, lead engineer,
director of sales. Their efforts drive the success and, therefore, revenue of your company. To reward their performance and entice
them to stay, you can give them phantom
stock. You pay them a reward equal to the
increase in value of your company over a
given time period. Phantom stock is a way
for you to share equity with employees without sharing the equity itself.
How do employees prosper?
Employees are paid based on the company’s performance, which is motivating
because their hard work and contribution to
the company’s success do not go unnoticed.
They feel more tied in to the company and
that what they do on a daily basis really matters. And it does. As the company grows,
employees who are rewarded phantom
stock make more money. This incentive is in
addition to salary, health insurance and other fringe benefits, like automobiles. Phantom
stock adds to the appeal of a recruitment
package, and the promise of eventually earning phantom stock will encourage workers to
stay on board. Shareholders also prosper
because employee interests become aligned
with their own.
Does phantom stock have certain limitations? Are there businesses that should not
offer this incentive?
If you are considering selling or merging
your business in a couple of years, you may
rethink phantom stock. A potential buyer will
see that you have promised to pay phantom
stock, which is essentially tied-up cash.
Limitations on phantom stock are mainly
associated with administering the plan.
Phantom stock must be carefully modeled by
a professional who understands the program
and the governing tax law, which includes
Section 409(A) of the IRS code.
What steps are necessary before implementing a phantom stock program?
First, ask yourself why you want to implement a phantom stock program. If it’s because you want to share the economic value
of the business and reward key managers for
success and performance without diluting
the value of the company, then you’re on the
right track. Second, remember that these
plans must only benefit a select group of
management employees, otherwise it might
make it an ERISA plan. Third, decide which
key managers are performance-drivers —
whom do you consider critical to your future
success? These should be your candidates.
Finally, you must determine the value of
your business and quantify the financial
impact of the company. Many business owners misjudge the value of their own businesses. At this point, enlist the aid of a tax and
accounting consultant who is also well-versed in phantom stock and the tax law surrounding these programs. A program must
be modeled so it complies with the Section
409(a) IRS code that governs phantom stock
plans.
TYLER RIDGEWAY is director of the Human Capital Resources Group at Kreischer Miller, Horsham, Pa. Reach him at (215) 441-4600
or [email protected].
