Intro to phantom plan

About the plan

A phantom plan, also known as a virtual plan, is a type of ESOP that gives employees a share in the company’s success without actual stock ownership. Instead, the employees get phantom shares which entitle them to a cash bonus payable typically on exit. The value of phantom shares mirrors the value of actual shares. When the company valuation increases, the value of phantom shares grows as well.

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Asset type

A phantom share embodies a right to a cash bonus payable typically on exit. The value of that cash bonus depends on the evolution of the company valuation over time. Simply put, the cash bonus will be calculated as the fair market value of the phantom shares at payout minus the fair market value of the phantom shares at grant. 

Best for

Phantom plan is ideal for early-stage to growth-stage startups that want to get started with their ESOP fast. It doesn’t require any corporate reshuffling, so it’s a perfect fit for first-time adopters.  

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Employee rights

Employees with phantom shares have a right to receive a cash bonus, but they don't have any shareholders rights. This means that even though they have a financial stake in the company's growth, they don't have voting rights or other shareholder privileges.

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Cap table effects

Technically, phantom shares don’t enter the company cap table. But because virtual ESOP impacts the economic position of the company, we recommend including it in the company’s fully diluted cap table for easier communication with investors. 

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Payout

The payout trigger needs to be defined in ESOP terms. By default, the phantom plan is settled on exit. Alternatively, the company can (but doesn’t have to) buy back phantom shares for their current fair market value. This is typically done when an employee leaves the company. 

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Taxation

Payout from a phantom plan is viewed as an employment-based bonus, so it’s typically taxed as employment income. 

But taxation laws vary across countries. Make sure to consult tax professionals to confirm the exact treatment in your location. If you need any help, schedule a call with our legal team here.

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Implementation steps

1. Design the plan: Define plan parameters like eligibility, vesting, payout events etc. 
2. Draft and approve documents: Prepare ESOP terms and award agreements. An award agreement can take the form of an employment contract clause, a side letter or a separate agreement.
3. Give awards: Sign award agreements with employees.
4. Inform your employees: Educate employees about the plan, its benefits and tax treatment.
5. Manage the plan: Make new awards, manage leavers and keep track of vested assets.

To save time, use our market standard phantom plan available in the Eldison platform. Design your ESOP parameters and we’ll generate legal-proof digital documents ready for signature.

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Pros & Cons

Pros:

• Works with any corporate structure
• Simple and inexpensive setup
• No cap table presence
• Easy transition to a different plan

Cons:

• High taxation on payout
• Secondary market doesn’t work
• Represents a liability on company’s side

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Something extra

Phantom plans are often the go-to plan for early-stage startups. This is thanks to their simple setup and management. Phantom plans are also very flexible so companies often switch to an asset-based structure (stock options or RSUs) once they have more resources to invest into their ESOP and more clarity about the company’s direction.