Use Phantom Stock to Retain and Reward Good Employees

How do you motivate and retain employees who are essential to the company's success without granting them an actual ownership stake? It's an ongoing challenge for many contractors and construction firm owners in virtually any phase of the business cycle.

During this prolonged economic downturn, any serious thinking by owners about long-term employee incentive programs has probably slipped to the bottom of the to-do list. But as the construction industry slowly climbs out of the doldrums, it may be time to think ahead.

Keeping this rare and valuable category of employee in the fold may require certain innovative incentives beyond the traditional 401k, health insurance and other typical perks. But at the same time, the business owner may not [yet] want to enter the "no-return zone" of ceding true ownership control.

Phantom Stock

One solution is the seemingly little known practice of issuing so-called "phantom" stock. Phantom stock is a technique (method) that confers some of the benefits of ownership to an employee without ceding any ownership control of the company. As mysterious as it may sound, the technique has numerous and comforting benefits for both the employer and the key employee.

The phantom stock method can be appropriate for any non-public company of any size. All you need is one or more key employees who you want to retain and reward.

Benefits

• Less hassle to set up and monitor - Unlike its more conventional brethren, the issuing of phantom stock is considered a non-qualified benefit. As such, it avoids much of the paperwork, restrictive rules and reporting requirements that are typical of traditional qualified benefit plans.

• Complete control of plan terms - As a non-qualified arrangement, owners have total flexibility to determine how the plan contract is drawn up, which employees participate, when and how many shares are granted, terms of vesting, payout schedules and similar details.

• Protects ownership control – Since phantom shares come with none of the statutory shareholder rights under corporate law, the full authority for company decision making remains with the owner(s). Any rights of the "phantom shareholder" are limited to rights specifically stated in the phantom plan.

• Spurs employee motivation and productivity – High-value workers now have more than just a job and a paycheck to keep them interested. They are in it for the long haul, especially if payout terms are tied to long-term company performance.

Sense of Ownership With Little Down-Side Risk

At its core, phantom stock is a highly effective compensation tool that allows key employees to enjoy a sense of "ownership" in the company – to share in its future success without necessarily sharing in the voting control, profits, dividends or distributions that normally come with the issuance of legal equity or stock options.

From the employee's standpoint, the potential financial reward of participating in a well-designed phantom stock plan will closely mimic the payoff of actual equity or options; hence, the names "mirror stock" and "shadow stock" that are sometimes used to refer to these plans.

Yet many of the risks and liabilities that ordinarily come to executives and others with direct, legal equity ownership are avoided with this pseudo version of company stock. For instance, the employee isn't required to infuse cash into the business, isn't exposed for corporate governance issues, and isn't required to personally guarantee company debt.

How It Works

Let's say the business owner awards one of his high-value executives 5,000 shares of phantom stock. Rather than having actual equity value, the phantom shares mirror the value of real company stock at, say, $20 a share.

The phantom stock plan that the owner has devised beforehand typically spells out a customized formula or generally accepted method for valuing the shares at some point in the future, say three years down the road. When the time comes, the company schedules a valuation and determines that the owner's stock is now worth $40 a share. The employee receives a payment of $20,000 – his or her reward for staying with the company and contributing to its growth.