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What Is Phantom Stock and How Does It Work

Phantom Shares: What they are and how they work

Phantom Shares: What they are and how they work

Phantom Shares are a truly useful mechanism for attracting or retaining talent and making the employees of a startup feel part of the project by making them participants in the economic benefits obtained by the startup.

When you become a partner of a company, you acquire participations or shares of the company, which give you a political vote (each share/participation gives you the right to vote on company decisions) and an economic vote (in case of an exit, partial or total sale, dividend, IPO… you have the right to the economic benefit arising from this liquidity event according to the participations/shares you hold.

Phantom Shares, on the other hand, are not shares or participation in the startup, they are not equity, but function as a bonus for objectives and are economic rights associated with the startup's future. Therefore, they do not have political rights, but only economic rights.

This right is recognized as consideration for the employee's commitment to remain with the company, so that it operates as a real incentive for the employee to remain linked to the project in the long term.

Phantom Shares are a perfect fit for startups or any company that will experience an increase in value over the next few years. They are attractive to both the company and the beneficiaries because neither has to bear costs until the time they are executed.

How Phantom Shares work

The employee is granted the possibility of exercising his or her Phantom Shares at a specific time previously agreed upon, and upon exercise will receive an economic compensation for the difference between the value of the share/participation at the time it was granted and the value it has at the time the option is exercised.

Advantages of Phantom Shares
  • They do not require an initial disbursement by the company or the beneficiary.
  • They are flexible, since the terms and conditions are determined by the parties, since it is not a regulated figure.
  • The beneficiary of the plan may not hinder the adoption of relevant resolutions, such as the approval of share capital increases to allow the entry of potential investors, the sale of the company, the transfer of a majority stake in the capital, the execution of operations involving a change of control or its IPO.
  • Loyalty, retention or incentivization of key employees. Fundamentally, they align the work team with the economic interests of the startup.
  • It is not equity. The Phantom beneficiary does not become a partner of the company, although he enjoys its main advantage: economic rights. Therefore, his interest is focused on the fulfillment of the objectives set for the exercise of his economic rights. In addition, there is no dilution for existing or future partners, nor is the distribution of capital atomized, which facilitates the management of the startup, maintaining its attractiveness to investors.
  • They are potentially more advantageous for the taxation of their beneficiaries than an increase in salary or turnover of traditional services.
Shape and structure

Because it is an atypical shape, its form is very flexible and can be designed in many ways. Phantom Share plans can have limits, options and performance ladders. The usual practice is to establish a timetable and a series of conditions which, if fulfilled, lead to the beneficiary employee being paid a certain or determinable amount. On the one hand, there is the vesting time (vesting) and the vesting deadlines (cliff).

Phantom Shares can be linked to the company reaching certain results, economic or valuation milestones, the company being sold or dividends being distributed, the company reaching a certain length of service or permanence, etc. These events or milestones are usually called triggers, since their confirmation causes the beneficiary to accrue the right to obtain his or her remuneration. Therefore, when designing them, it is important to bear in mind the characteristics of the startup and its medium- or long-term objective.

It is common for the Shareholders' Agreement to include certain limitations when designing a Phantom Shares plan. Or even that it is equated to other special compensation plans, such as stock options or profit sharing.

In terms of form, phantom share plans are usually negotiated on a group basis (with a basic document of general conditions or term sheet and invitations to participate) or on an individual basis (by signing an agreement with each beneficiary).

In short, phantom shares have the advantage of serving as an instrument of employee loyalty by making them participants in the company's economic growth, but without transferring to them the political rights of shareholders. This is why they are increasingly being adopted by companies, especially startups today.

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About Bcombinator

Bcombinator is a coworking space that helps entrepreneurs and professionals to incubate, accelerate and consolidate their business. It offers personalized services led by a network of prestigious mentors who offer their experience from the gestation phase of an idea to internalization, applying Lean Startups techniques.

On the other hand, it has an investment fund, Bcapital I, endowed with €1,000,000 to invest bills of up to €50,000 in pre-seed rounds. The goal of this VC is to invest in the best startups at the end of the Bcombinator Incubation Program at Demo Day.

It also organizes events where networking, innovation and collaboration are encouraged.

What Is Phantom Stock and How Does It Work

Source: https://bcombinator.com/phantom-shares-what-they-are-and-how-they-work