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SuraLinkWritten by Daniel J. Brock, CPA, CVA
If you are looking to reward and incentivize key members of your management team, you may want to consider a “phantom stock” award. Phantom stock awards give employees a stake in the potential growth in value of your company without giving them the legal rights of a stockholder, such as voting or dividend rights. This allows full legal control of the company to remain with the current ownership team while providing your key leaders with an incentive to stay with you and help drive that growth.
The employee will not have to pay for the stock or recognize taxable income at fair market value in the form of compensation. This means there is no adverse effect on them when the plan is started like there would be with traditional stock options.
The award is typically payable upon either a sale of the business or the retirement of the key employee but you have the freedom to set a different triggering event, such as making a portion of the bonus payable when the value of the company reaches a certain threshold.
For a closely-held company, one of the key components of a phantom stock plan will be determining the value of the award. This sets the baseline and the final value on which the bonus will be paid. There are many different business valuation methods that could be used for this purpose. One of the more common methods would be a multiple of historical cash flows, with the multiple depending on a variety of factors such as your industry, competitors, experience of your management team or other risks specific to your business. A Certified Valuation Analyst (CVA) would be able to assist you with all aspects of determining the value to be used in the award calculation.
If you’d like to discuss your options for phantom stocks further, please contact one of our BMSS valuation specialists. They are available to answer any questions you may have and provide you with steps for setting up a phantom stock award plan.