How to incentivize my key employees? Everything you need to know about stock options and phantom shares
One of the great challenges for any company is the recruitment and retention of talent. For this, different incentive systems have been used, highlighting those whose benefits are linked to the results of the company.
For example, the delivery of stocks and shares has traditionally served to align managers and key employees with the company's objectives. And this because they promote a greater commitment, to the extent that the revaluation of the company will have a direct impact on the assets of the key employee.
However, these traditional tools have some problems that can make them inconvenient. Especially in the case of startups and companies with fast growth or with a certain financial voracity.
Precisely for this reason, it is within startups that the two forms of incentives that we want to analyze today have appeared: stock options and phantom shares.
What are stock options?
A stock option is nothing more than a call option on company shares. As compensation to the employee or collaborator for their commitment to the company, the company offers them the possibility of acquiring shares at a lower price than the market price.
The key pieces of stock options
When establishing a stock options program it is important to know the most important elements of its operation. These are:
The stock option is configured as a purchase right under favorable conditions.
Therefore, when the employee signs the incentive or remuneration contract, he will be granted a purchase right that should detail:
-A vesting period or grace period, during which the right may not be exercised.
-An expiration period, after which the purchase option cannot be exercised either.
-The price at which the share can be acquired. It is known as a strike and can be nominal, although the most common is that the real value of the share is used at the time the contract is signed. In this way, the employee will strive to grow the company, because the more it revalues, the greater will be its profit at the time of exercising the right to purchase.
-The moment in which the right to purchase can be exercised. In this sense, it is usually used:
- The exercise of the option implies the acquisition of real shares. Therefore, if the employee chooses to buy his shares, he will become a full partner of the company.
- Stock options are considered remuneration in kind. So if the worker ends up exercising their right to purchase, they will be subject to personal income tax and a quote.
Stock options program dynamics
As we can see, when a company introduces a variable remuneration system based on purchase options, it can incentivize executives, collaborators and key employees without compromising its liquidity.
The most common is to establish one or more grace periods, after which the worker will be able to acquire a package of shares. To avoid that your right is extended indefinitely in time, an expiration period is also established.
During this time frame, the worker may acquire shares at a previously agreed price. This implies that they will be predictably cheaper than in the market if the company has been positively revalued.
What are phantom shares?
Phantom shares are titles that represent a right to collect an amount equivalent to the value of the shares or participations of a company. In other words, it is an instrument similar to the share or participation itself, but which only has an economic content. Therefore, it does not carry the political rights that owning a real share or participation entails.
The key pieces of phantom shares
The phantom share is a collection right. Therefore:
It does not entail political, informational, separation rights from the partners of a company, protection or any other associated with shares or real interests.
Until it becomes effective, it does not imply a profit for the incentivized person or an expense for the company, but merely an expectation of collection.
Like phantom shares, they are regulated in a contract, where attention should be paid to details such as:
-Vesting periods, as in the case of stock options.
-Liquidity events, which are milestones relevant to the company or objectives to be achieved
The number of phantom shares assigned to the incentivized person.
Its revaluation rules. The phantom share is usually valued at the same price as the shares or participations at that time.
The requirements for the right of collection to be exercised. For this, the following are usually established:
The transferability or not of the right. Generally, companies prevent this right from being transferable, although sometimes they admit the possibility of “buying it” once the vesting period has passed.
Contrary to what happens with stock options, phantom shares are not related (except in their price) to shares or real shares. Therefore, the incentivized person may collect their economic rights, but at no time will they acquire political rights.
At the time of collection, the expectation will be updated as an extraordinary performance of the work, which implies the subjection to personal income tax and to quotation.
Phantom shares program dynamics
The dynamics of the phantom shares program is similar to that of stock options.
At the time of hiring, a right is constituted in favor of the key employee. If the payment conditions are met (expiry of the grace period and achievement of objectives), the latter will have the right to collect the difference between the current value of the shares and the one they had at the time of signing the contract.
When am I interested in using each system?
To find out which system should be implemented, it is best for the company or startup to request assistance from specialist company lawyers. Poor planning of the incentive program will have significant economic, accounting, tax and employment consequences.
Despite this, the truth is that startups tend to go preferably to phantom share systems, because:
They are more flexible, as they are not regulated by law.
They have a more favorable tax regime.
They avoid loss of control and the dilution effect.
However, it is impossible to determine whether the advantages or disadvantages of each of these options will affect the company favorably or unfavorably without conducting a detailed study.