27 June 2022

Phantom shares - virtual shareholdings

  • Articles
  • Legal
  • Employment / Immigration
  • Transactions / M&A

Participation programs offer excellent opportunities to motivate employees and win them over to the company. The allocation of phantom shares can be an alternative to the allocation of "real" shares.

Attracting and retaining talent

Particularly in growth companies, employee share ownership is often an important method of attracting talent and retaining it in the long term. Participation programs can be designed in such a way that employees receive shares and thus participate in periodic profit distributions and/or can sell their shares at market value in the event of a company sale.

A disadvantage of such participation programs is that the shareholder base of the company is expanded by a large number of small shareholders, which increases the administrative workload and impairs control over the shareholder base. In addition, certain rights (e.g. rights of information and inspection) are associated with the position as shareholder. Furthermore, it must be ensured that individual small shareholders cannot prevent the sale of the entire company to a third party. Particularly in the case of a separation of employees, it should be ensured that there is a possibility of buying back shares that have already been allocated.

A phantom share program is a way of allowing employees to participate economically in the long-term success of the company without granting them an actual shareholder status. The phantom share is a virtual participation that mirrors the value of a share and puts the beneficiary (partially) on an equal footing with a shareholder in terms of financial rights. Accordingly, the beneficiary usually receives payments corresponding in amount to the respective dividend distributions or the realized capital gains on exit. The Board of Directors of the company determines the parameters of the phantom shares by means of a phantom share plan (PSP).

Main provisions of the phantom share plan

  • Maximum number and terms of allocation of phantom shares: The Board of Directors usually endeavors to allocate phantom shares as far as possible at its own discretion and to grant the beneficiaries mandatory entitlements only as part of the actual allocation by individual phantom share agreements.
  • Vesting conditions/deadlines: In order to ensure a long-term commitment, allocated phantom shares are vested over a certain period of time, with unvested phantom shares expiring at the time of termination of the employment contract.
  • Rights to dividend equivalents: The Board of Directors is free to determine in what proportion an equivalent to the dividends distributed by the company should be paid to the phantom shareholders.
  • Definition of liquidity events (sale, IPO, etc.): The actual realization of the participation in the company value takes place through a settlement of the phantom shareholders for their phantom shares at the sale or market value, whereby the Board of Directors defines the time, conditions and implementation of such an exit.

Advantages compared to classic participation programs

  • Sole authority of the Board of Directors: Neither a resolution of the General Meeting nor the involvement of a notary public is required for the creation of phantom shares. Furthermore, no adjustment of the company's articles of association or entry in the commercial register is required.
  • Beneficiaries only receive asset rights: the shareholder structure is not affected, which makes it easier to handle general meetings and, in the event of a sale of the company, clear structures can be shown to a potential buyer.
  • Tax consequences only upon payout: Although the beneficiaries must pay tax on payments from phantom shares as income, they do not have to pay tax on them until they are actually paid out. This means that there are no tax consequences when the phantom shares are allotted - and at the time of payout, sufficient liquidity is available to settle the taxes.

Stumbling blocks in design/handling

  • Labor law: The allocation of phantom shares should not take the form of a variable salary component, but only as a gratuity ("bonus").

  • Termination: The resignation of employees and any forfeiture of phantom shares must be regulated.

  • Accruals: The accumulated claims of the beneficiaries must be reported by companies in the balance sheet and disclosed to the buyer in the event of a possible sale of the company.

Our start-up team will be happy to advise you on all questions regarding the introduction of phantom shares.