Phantom Shares and how to incentivize your startup’s employees

PHANTOM SHARES

If you have a growing startup and you need to start hiring workers, in this article we are going to talk about an issue that will interest you. If you have a growing startup and you need to start hiring workers, in this article we are going to talk about an issue that will interest you.

These are phantom shares, a variable remuneration system that will allow you to reduce personnel costs before your startup is consolidated.

If you want to know more about this form of payment so used in the world of startups, we will explain it to you right now.

What are phantom shares?

“Phantom Shares” commonly refers to a program in which employees receive economic benefits that are linked to the value of the company’s shares, but without actually receiving shares in the company.

Through this bonus, the company grants the employee economic rights that equate to an equity stake, however, it does not confer the associated political rights.

Unlike stock options, which allow employees to acquire a real stake in the company’s capital stock, the Phantom Shares mechanism is characterized by the fact that it does not confer at any time the status of partner to the employees. Instead of granting direct ownership, they offer economic rights linked to the financial performance of the company, thus providing an alternative that does not involve the assumption of corporate roles by employees.

Although the Phantom Shares do not represent real shares but are fictitious units, their reference value is directly linked and proportional to the company’s real share capital. This ensures that the beneficiaries of Phantom Shares experience an economic stake in the financial performance of the organization, as their rewards are intrinsically linked to the real value and success of the share capital, thus providing a meaningful connection between compensation and business performance.

This type of reward is widely used in the context of startups to incentivize their employees. In this model, the variable compensation received by the employee is directly linked to the company’s growth, thus generating an intrinsic link between individual effort and collective prosperity. Thus, as the startup experiences an increase in its development, employees are incentivized proportionally, fostering a culture of collaboration and alignment of interests in the work environment.

Now that you know what they are, let’s see how they work.

How do phantom shares work?

funcionamiento de las Phantom Shares

In many European countries, including Spain, Phantom Shares are characterized by the absence of specific legal regulation, thus providing considerable flexibility to define the terms of grant and performance at the discretion of both parties involved. This lack of legal restrictions gives employers and employees the freedom to tailor these compensation programs in a more personalized and tailored manner to the particular needs of the company, allowing the creation of arrangements that are optimally aligned with the strategic objectives and specific circumstances of each situation.

Although it depends on each particular case, a calendar and a series of conditions are usually agreed upon in advance, which, if fulfilled, imply the collection of a certain amount by the company’s employees.

If you are contemplating the implementation of this system in your startup, it is crucial to have a clear understanding of how Phantom Shares operate in response to three fundamental questions:

How does the worker get his phantom shares?

It is essential to define the process by which employees will earn these phantom shares. This involves establishing criteria, such as length of service, individual performance or specific goals, that will determine the allocation of Phantom Shares.

Vesting is known as the way in which the employee earns the right to receive these Phantom Shares.

Typically, vesting is associated with the achievement of a number of milestones: for example, the hiring of the employee, the company reaching a certain turnover or the closing of a new round of financing.

Phantom Shares are usually granted to the employee as a personal and non-transferable right so that if he/she leaves the startup before a certain period, he/she will lose his/her rights to them.

On other occasions, clauses are added to the contract that allow the beneficiary to sell the Phantom Shares at a certain price to the startup itself or other employees as long as they have been with the company for a certain period.

When can the worker receive his equivalent amount in cash?

The timing of the conversion of Phantom Shares into cash equivalents is a key consideration. Clearly establishing the times or events that will trigger the possibility of conversion provides transparency and predictability to employees, while aligning interests with business objectives.

The employee gradually vests his or her Phantom Shares over a period known as the vesting period, during which time if he or she leaves the company he or she would only be entitled to receive in the future the corresponding Phantom Shares that have vested up to that point.

The contracts specify the conditions under which the employee or former employee will receive cash compensation for the vested Phantom Shares.

Generally, this occurs when an outside investor acquires all or a majority of the company’s shares, with part of the purchase proceeds intended to settle these rights.

What is the cash value of each phantom share?

Defining the monetary value associated with each Phantom Share is essential to determine the actual compensation employees will receive. This can be based on the current value of the company, financial performance or any other relevant indicator.

The value of a Phantom Share is calculated in relation to the value of each share of the company’s stock at the time of sale.

Generally, this cash amount is calculated based on the increase in the value of each share from the grant of the Phantom Share to the time of sale.

In order for you to know whether or not this compensation system is right for you, we will discuss its advantages and disadvantages below.

Addressing these questions clearly will provide a solid framework for the successful implementation of Phantom Shares in your startup, ensuring a mutual understanding between the company and its employees about the functioning and benefits of this compensation system.

Advantages and disadvantages of phantom shares

There are many advantages that this system presents compared to salary increases or other instruments such as stock options. Among them, the following stand out:

pahntom shares en startups

Encourage employees to help the company grow

Given that the bonus that the worker receives will depend on the revaluation of the startup over time, phantom shares allow us to align the economic interests of the management team with those of employees and collaborators.

Allows you to retain the best employees

Given that there is a vesting period during which the worker consolidates the award of their economic rights, this system ensures the permanence of the startup’s employees, thus helping to retain talent in the company.

Thus, if the employee leaves before completing this period, she will receive less extra remuneration.

It allows the startup to reduce initial costs

Because a fraction of the employee’s salary is subject to variations linked to its performance, this system enables the company to lower its initial fixed costs, thus avoiding incurring excessively high costs and minimizing the associated financial risk.

The flexibility inherent in this variable salary structure provides a strategic approach that adapts to the changing phases of business development, allowing the company to manage its economic resources more efficiently according to market conditions and the results obtained.

It does not affect the equity of the startup

As the workers do not become partners in the company, it is a very attractive system both for them and for new investors since it does not involve dilution for either party.

On the other hand, phantom shares have two main drawbacks for their beneficiaries:

  1. They imply a tax impact for the worker since they are considered income from work, so she must declare her personal income tax as a salary income depending on the real price of the startup’s shares
  2. They are usually agreed without the possibility of assignment to third parties in case of being sold.

As you can see, phantom shares are something quite complex to understand and above all, to carry out.

At The Startup CFO we are specialists in providing financial management services to small startups and SMEs in the technology sector, so if you want to have our help to create a phantom shares plan in your company, we invite you to contact us. We are here to provide you with the necessary assistance and design together a customized plan that fits the specific needs of your business. Don’t hesitate to contact us to explore how we can enhance your company’s growth and financial success!

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PHANTOM SHARES

Phantom Shares and how to incentivize your startup’s employees

If you have a growing startup and you need to start hiring workers, in this article we are going to talk about an issue that will interest you. If you have a growing startup and you need to start hiring workers, in this article we are going to talk about an issue that will interest you.

These are phantom shares, a variable remuneration system that will allow you to reduce personnel costs before your startup is consolidated.

If you want to know more about this form of payment so used in the world of startups, we will explain it to you right now.

What are phantom shares?

"Phantom Shares" commonly refers to a program in which employees receive economic benefits that are linked to the value of the company's shares, but without actually receiving shares in the company.

Through this bonus, the company grants the employee economic rights that equate to an equity stake, however, it does not confer the associated political rights.

Unlike stock options, which allow employees to acquire a real stake in the company's capital stock, the Phantom Shares mechanism is characterized by the fact that it does not confer at any time the status of partner to the employees. Instead of granting direct ownership, they offer economic rights linked to the financial performance of the company, thus providing an alternative that does not involve the assumption of corporate roles by employees.

Although the Phantom Shares do not represent real shares but are fictitious units, their reference value is directly linked and proportional to the company's real share capital. This ensures that the beneficiaries of Phantom Shares experience an economic stake in the financial performance of the organization, as their rewards are intrinsically linked to the real value and success of the share capital, thus providing a meaningful connection between compensation and business performance.

This type of reward is widely used in the context of startups to incentivize their employees. In this model, the variable compensation received by the employee is directly linked to the company's growth, thus generating an intrinsic link between individual effort and collective prosperity. Thus, as the startup experiences an increase in its development, employees are incentivized proportionally, fostering a culture of collaboration and alignment of interests in the work environment.

Now that you know what they are, let's see how they work.

How do phantom shares work?

funcionamiento de las Phantom Shares

In many European countries, including Spain, Phantom Shares are characterized by the absence of specific legal regulation, thus providing considerable flexibility to define the terms of grant and performance at the discretion of both parties involved. This lack of legal restrictions gives employers and employees the freedom to tailor these compensation programs in a more personalized and tailored manner to the particular needs of the company, allowing the creation of arrangements that are optimally aligned with the strategic objectives and specific circumstances of each situation.

Although it depends on each particular case, a calendar and a series of conditions are usually agreed upon in advance, which, if fulfilled, imply the collection of a certain amount by the company's employees.

If you are contemplating the implementation of this system in your startup, it is crucial to have a clear understanding of how Phantom Shares operate in response to three fundamental questions:

How does the worker get his phantom shares?

It is essential to define the process by which employees will earn these phantom shares. This involves establishing criteria, such as length of service, individual performance or specific goals, that will determine the allocation of Phantom Shares.

Vesting is known as the way in which the employee earns the right to receive these Phantom Shares.

Typically, vesting is associated with the achievement of a number of milestones: for example, the hiring of the employee, the company reaching a certain turnover or the closing of a new round of financing.

Phantom Shares are usually granted to the employee as a personal and non-transferable right so that if he/she leaves the startup before a certain period, he/she will lose his/her rights to them.

On other occasions, clauses are added to the contract that allow the beneficiary to sell the Phantom Shares at a certain price to the startup itself or other employees as long as they have been with the company for a certain period.

When can the worker receive his equivalent amount in cash?

The timing of the conversion of Phantom Shares into cash equivalents is a key consideration. Clearly establishing the times or events that will trigger the possibility of conversion provides transparency and predictability to employees, while aligning interests with business objectives.

The employee gradually vests his or her Phantom Shares over a period known as the vesting period, during which time if he or she leaves the company he or she would only be entitled to receive in the future the corresponding Phantom Shares that have vested up to that point.

The contracts specify the conditions under which the employee or former employee will receive cash compensation for the vested Phantom Shares.

Generally, this occurs when an outside investor acquires all or a majority of the company's shares, with part of the purchase proceeds intended to settle these rights.

What is the cash value of each phantom share?

Defining the monetary value associated with each Phantom Share is essential to determine the actual compensation employees will receive. This can be based on the current value of the company, financial performance or any other relevant indicator.

The value of a Phantom Share is calculated in relation to the value of each share of the company's stock at the time of sale.

Generally, this cash amount is calculated based on the increase in the value of each share from the grant of the Phantom Share to the time of sale.

In order for you to know whether or not this compensation system is right for you, we will discuss its advantages and disadvantages below.

Addressing these questions clearly will provide a solid framework for the successful implementation of Phantom Shares in your startup, ensuring a mutual understanding between the company and its employees about the functioning and benefits of this compensation system.

Advantages and disadvantages of phantom shares

There are many advantages that this system presents compared to salary increases or other instruments such as stock options. Among them, the following stand out:

pahntom shares en startups

Encourage employees to help the company grow

Given that the bonus that the worker receives will depend on the revaluation of the startup over time, phantom shares allow us to align the economic interests of the management team with those of employees and collaborators.

Allows you to retain the best employees

Given that there is a vesting period during which the worker consolidates the award of their economic rights, this system ensures the permanence of the startup’s employees, thus helping to retain talent in the company.

Thus, if the employee leaves before completing this period, she will receive less extra remuneration.

It allows the startup to reduce initial costs

Because a fraction of the employee's salary is subject to variations linked to its performance, this system enables the company to lower its initial fixed costs, thus avoiding incurring excessively high costs and minimizing the associated financial risk.

The flexibility inherent in this variable salary structure provides a strategic approach that adapts to the changing phases of business development, allowing the company to manage its economic resources more efficiently according to market conditions and the results obtained.

It does not affect the equity of the startup

As the workers do not become partners in the company, it is a very attractive system both for them and for new investors since it does not involve dilution for either party.

On the other hand, phantom shares have two main drawbacks for their beneficiaries:

  1. They imply a tax impact for the worker since they are considered income from work, so she must declare her personal income tax as a salary income depending on the real price of the startup’s shares
  2. They are usually agreed without the possibility of assignment to third parties in case of being sold.

As you can see, phantom shares are something quite complex to understand and above all, to carry out.

At The Startup CFO we are specialists in providing financial management services to small startups and SMEs in the technology sector, so if you want to have our help to create a phantom shares plan in your company, we invite you to contact us. We are here to provide you with the necessary assistance and design together a customized plan that fits the specific needs of your business. Don't hesitate to contact us to explore how we can enhance your company's growth and financial success!