Phantom Shares: The trendy corporate incentives for talent retention

Phantom Shares: The trendy corporate incentives for talent retention

One of the main concerns we receive from our clients is the uncertainty in a labour market in which the recruitment of specialised professionals is becoming increasingly complex and talent retention seems almost impossible.

According to Randstad Research’s annual job turnover report, the average annual turnover figure for Spanish companies in 2022 is 17%. In the last year, 4 out of 10 companies have seen this turnover increase and at least 40% of companies expect these levels to change over the next 12 months. 

According to the report, the main cause of these figures is the gap in job opportunities that workers have in other sectors or companies. Startups, especially those in the technology sector, are forced to compete in the same market as multinational giants that are able to offer working conditions to strategic employees that they cannot compete with.

For this reason it is important to know the tools available to startups when it comes to making their value proposition profitable and how to make their projection their greatest attraction when it comes to retaining talent within the company, without having to incur high costs for the salaries of the key people who make the project possible. 

Phantom shares are an attractive solution when it comes to enabling employees to participate in the success of the company. They provide an alternative way to remunerate our company’s first employees and future key employees through their participation in the company’s profits and growth.

What are phantom shares?

Also known as “phantom holdings” (“phantom shares” in the case of public limited companies), they are a figure imported from the Anglo-Saxon world, whereby a system of incentives is established for employees and key collaborators, providing them with certain economic rights related to the growth and good functioning of the company. 

Phantom shares allow the holder to enjoy the economic benefits of the total percentage of these shares held. However, as they are not real shares, they do not have political or control rights over the company, i.e. they would not have any additional rights, such as the right to vote in different matters of interest to the company.

This is why they are known as phantom shares, as they are a simulation of a company’s shares, without actually being like them. In other words, their holders will enjoy some of the benefits of the company’s shareholders without actually being so.

Phantom equity is one of the different types of incentive plans that exist, along with stock options.

What are the main advantages of a phantom share plan?

The main advantages are twofold: loyalty and incentive. 

Loyalty because in this way you achieve a greater permanence of that team in your company by making the scalability of the business an attractive value for the employee. 

And incentivise, because in this way the employees are the main stakeholders in the achievement of objectives and in creating value for the company, as they are participants in the success of the project.

In addition, one of the main benefits of phantom shares is that the holder of the shares enjoys the economic rights of a partner or shareholder without having to make any outlay to acquire the shares or units.

This translates into benefits for the shareholders, as they will not see their control over the company diminished by maintaining important rights such as voting rights.

How do phantom shares work?

As we have mentioned, phantom shares seek to reward the work and effort of key employees by making the holder a participant in the profits that the company has obtained during the financial year, enjoying the corresponding economic rights associated with holding shares.

Thanks to these phantom shares, employees receive income in proportion to the number of shares allocated to them, so that they will receive a share of the corresponding percentage of the profits, of which they have been essential in carrying out key activities for the project. 

The said agreement shall indicate the parties to the agreement, i.e. the employee who is to receive the incentive plan, the shares or holdings to which he/she is entitled to the economic rights and any other additional requirements that are deemed to have to be fulfilled in order to give effect to the incentive plan. 

This profit share is paid as a bonus on the employee’s payroll. 

What is the content of a phantom shares agreement?

The essential content of a phantom share agreement must take into account both the percentage of shares to be allocated to it, its distribution, its duration and the essential conditions attached to the incentives: targets, form and timing of vesting, what happens in the event that key employees leave the company, etc.

Once these arrangements have been determined and drafted into a contract or phantom share plan, they must be approved by the General Meeting.

One of the essential aspects that will determine the effectiveness and the effect that a phantom share plan will have on the company will be the determination of the vesting period, as well as the selection of the monetisation or redemption event. Although it may be agreed that the delivery of these rights is immediate upon signing the agreement, it is common for a series of milestones or objectives to be established as conditions (the employee’s permanence, the achievement of a capital increase or the attainment of specific profits).

In any case, a phantom shares agreement offers great flexibility to the parties in the elaboration and drafting of its content, and various clauses can be included according to the negotiations between the interested parties.

How are phantom shares taxed?

The profits obtained through the phantom shares must be taxed as employment income within the IRPF, in the general base. For this reason, they will be accrued when they become payable, at which time the company must make the corresponding withholding as if it were the employee’s salary.

Moreover, given their irregular nature, i.e. they are not received periodically, they are eligible for a 30% reduction scheme when the generation period is longer than two years and if the additional requirements are met. This is due to the fact that a phantom share plan is equivalent to a salary bonus.

Phantom shares vs Stock options Which is better?

As we have seen, phantom shares can be enjoyed without the beneficiaries having to make any payment to acquire the shares or holdings, and the shareholders’ control over the company will not be diminished.

On the other hand, the implementation of stock option incentive plans does involve the conversion of stock options into shares or participations, with all the rights and obligations of the shareholders in favour of the beneficiary. In other words, they will not only represent economic rights, but will also have the political rights that come with being a shareholder in a capital company.

In addition to the aforementioned difference, stock option plans have a more burdensome tax regime. This is because, in addition to being taxed as employment income from the moment they are consolidated in favour of the employee, the gains obtained at the time of their sale must also be considered in the event that they are revalued, with tax being paid again on them at the moment they are executed.

LETSLAW

At Letslaw we have professional experts in drafting incentive plans for phantom shares, stock options, capital increases, among other services, so we can assist you in this type of operations.