​By Mercedes DeFeo

Don’t give your hard-earned business equity away to your employees like candy to trick-or-treaters! There is another way to compensate them for their contributions.  Phantom shares may sound spooky, but it is really the opposite.

Interest in a corporation is identified by “stock” or “shares,” while interest in an LLC is called “units” or “interest.”  For purposes of this article, Phantom Shares mean both corporate stock and LLC interests.  All business owners have certain rights, so if you give away equity, you are giving up some control in your business.

Phantom shares, also known as phantom stock or phantom units, are a way to compensate employees based on the overall value and performance of your business (normally, the profits), similar to how shareholders and LLC members are compensated via distributions and dividends. Phantom shareholders differ from regular shareholders because they are not given any of the rights a business owner would have.

Phantom Shares are awarded via a Phantom Award Agreement. Sometimes there might be a Phantom Share Plan if you wanted to set up a uniform system for awarding phantom shares to multiple employees in the company.  The Plan outlines the rules for distributing phantom shares to participants, such as eligibility, how the phantom share value will be determined, and how the shares vest. Depending on the plan, phantom shares may be considered deferred compensation, so it's important to involve your CPA.

Through the plan, you can specify a minimum number of days employed before an employee can participate, if value of phantom shares is based on the date your employee starts participating or if value appreciates as the company grows, whether the vesting of phantom shares is based upon continued employment with the company or if termination impacts payout, etc.  If you give an employee equity, you can’t take it back if their employment terminates...you have to buy it back!  Now that’s scary!

Phantom shares are a great way to create motivation and drive in your employees to give their all towards the success of your business, without you being haunted by the idea of losing control over it.

Happy Halloween from Jesson & Rains!