Phantom shares are one of the best ways to incentivize your team. The challenge is that they’re a completely unfamiliar concept outside the venture capital ecosystem. Once a founder understands them and wants to explain them internally, they face a new problem: how to do it without losing the audience in the first paragraph.
In this article, I’m not going to explain what phantom shares are since probably you already know that. Instead, I’ll give you the keys to explaining them to someone with no financial background who has never heard of them before.
The first and most important step is to make it clear from the outset that there are no actual shares involved. No equity, no ownership, nothing of the sort. Phantom shares are, in reality, much more “phantom” than “shares.” They are simply a formula to calculate a bonus one that is only triggered at a very specific moment: if the company is sold. Getting this point across early prevents confusion that can be very difficult to fix later on.
Second, you need to explain how that bonus is calculated. The key idea is simple: the employee will receive compensation as if they owned a certain number of real shares in the company. If someone has 100 phantom shares and the company is sold, they will receive exactly what they would have earned with 100 real shares. When explained with a concrete numerical example, this usually clicks.
Finally, you need to explain vesting. This concept means that this right is earned progressively over time, not all at once. The most common structure is a four-year schedule: if the employee leaves before the first year, they earn nothing; after one year, 25%; after two years, 50%; and so on until reaching 100% after four years. Contracts can include many variations and additional conditions, but the core concept remains the same.
In the end, the message you want to convey is simple: this is a bonus that can be highly lucrative if the company is sold, designed to align the team’s incentives with those of the founder. Nothing more. The simpler the explanation, the better it will be understood. And even more imporant: Appreciated.
In the next articles of this series, we’ll tackle two equally important questions: how much to allocate and how to structure it, and who in your team should actually receive it — a more nuanced decision than it may seem. Keep reading!
