In working with family businesses, we get a lot of questions about how to compensate non-family executives. Unlike their family counterparts, giving away hard equity of the business to non-family employees is not always an option. While companies want to reward their significant contributors in ways beyond just salary and bonus in order to retain their talent to remain successful, owners don’t want to dilute their ownership in the process. This is where the use of a phantom stock plan may be appropriate.
What is phantom stock and how does it work?
Phantom stock is a form of deferred compensation by which a company calculates and tracks a cash benefit to be paid at a future point in time. As a result, it is used as a long-term compensation incentive. The plan allows for benefits to accrue to a participant. The benefit is based upon the performance of the business, typically using some type of formula or metric. The benefits are paid to a participant upon the occurrence of a triggering event such as death, disability, or retirement.
What are the advantages of phantom stock?
The significant advantage for a family business is that no stock or equity is actually given up, and therefore, the family can remain in control of the business. The other advantage is that there are no immediate tax implications until the actual benefits are paid. Payouts can also be customized.
What are the disadvantages?
The biggest disadvantage is that a liability needs to be recorded on the books of the company for financial reporting purposes, which could impact financial covenants. The other disadvantage is that the liability can grow quite quickly, so it requires attention.
With some thoughtful planning and monitoring, a phantom stock plan may be a good choice to reward your key employees for your family business.
Have you used phantom stock in your family business? How has it worked out? Share in the comments.