Should I setup a stock option or phantom share plan? That’s the first tricky question on the way to your new participation plan. The following guide will help you decide which one suits you more.
Stock Option Plan
- A standard that is more accepted and common in other countries, in particular the US and the UK.
- Employees who exercise options become real shareholders, putting them on the same level as the founders and investors. This makes them feel more strongly connected to the company and motivates them to stick with it longer.
- Employees are able to become shareholders of the company for a lower share price than investors.
Exercising process adds a complexity layer:
- Harder to understand for employees who are not experienced in this field. For example they have to decide if and when they want to exercise.
- The company needs to go to the notary once a year if options were exercised.
- Employees have to pay (income) taxes and social security contributions when exercising. This usually requires a tax ruling to reduce the tax burden, which costs once to set up.
- Employee who exercise have voting rights in the general assembly and therefore also certain rights to information. Some companies don’t feel comfortable with this. However, to mitigate this a company can always limit the scope of recipients of an ESOP to certain key employees.
Phantom Stock Plan
- It’s easy to implement and run: Only contractual agreement, no real share issuances/transfers involved, in fact almost like a bonus payment. Therefore e.g. no need to go to the notary and to do a tax ruling.
- Easier to understand: Especially for employees who don’t have experience with options and the process of exercising them. They just get a share of the exit sum or other defined cash events, that’s it.
- No financial risk: Employees only pay taxes when money is flowing, which makes it easier to bear.
- Less common/understood by US and UK investors.
- No tax optimization: Payment of more taxes overall compared to ESOP plan.
- Employees don’t become real shareholders, putting them on a second layer compared to the founders and investors. This gives them less security that their rights are protected and makes them feel less connected to the company, reducing their long-term commitment.
- Allocated and outstanding phantom stocks are a liability of the company (that likely grows) which needs to be monitored with regard to a company’s accounting and liquidity needs (also in view of a possible IPO).