Phantom Stock

by | Oct 6, 2022 | U.S. Corporate Law | 0 comments

Finding the right balance between providing incentives to stakeholders while maintaining as much equity in your company as possible can feel as elusive  as winning a golden ticket from Willy Wonka.

The question becomes, what is an effective way to do so? Growth-oriented companies want to grow.  It’s that simple.   These companies may not,  however, want to give away equity in the process. As such, these growth-oriented companies can compensate high-performing employees and stakeholders in other ways without giving away equity in the company.  This is important to know not only for companies that want to retain as much equity as possible, but also for those who may not have an immediate budget for incentives or those where the company is not able to give away equity because the owners of the company are part of a specific licensed group of professionals.  Think of lawyers, architects, and accountants.  This article focuses on an incentive referred to as phantom equity.   Phantom equity provides a way for companies to compensate stakeholders based on the value of the traditional stock price of the company, yet without giving away equity in the company.  The stock price of a company is tied to its performance, so providing company stock based on this value, incentivizes stakeholders to work in the best interests of the company.  This can be used by large public companies and by smaller privately held ones, yet one should also consider a valuation of the company, to know the value of the interest the owner has.

I. Introduction

Two people looking at documentsGrowth-minded business owners can use phantom equity not only as a way to pay and motivate their employees yet also as a creative tool to compensate investors, seasoned consultants, and third parties so they can grow their company, minimize the use of operating cash, and not lose equity in the process.  Influential economist and investor Benjamin Graham noted, “The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.”

Phantom stock, also known as “shadow stock” or “simulated stock” is one plan that will help growth-oriented businesses go where they want to go;  it provides investment in the company without diluting the existing equity holders.  Phantom stock is not the most common option, yet both business owners and employees benefit. So, let’s explain how it works.

II. What is Phantom Stock?

Growth-minded companies face the challenge of how to grow without giving away their equity. For example, if you own 100% of the company and give 10% to an investor, then you have 90% left.  This is not bad at first; retaining 90% is still very good.  The challenge comes later when there is not only one investor but rather multiple investors, or perhaps a hedge fund, or perhaps you reserve an equity percentage for future employee stock and then reserve another amount for future investors, another for board member shares, or another amount for another future use.  Suddenly, that 100% equity is quickly and easily whittled down in the name of greater growth. While growth-minded owners may suddenly see their growth scaled exponentially and, perhaps as a result of the investor, they are now able to have product placement in 5000 U.S. stores across the country and maybe even globally, their 100% equity might now be whittled down to 40%, 20%, or less.  The years of sacrifice and diligence proved worthwhile, because now they have a company with national impact, yet the original owner owns very little of it;  often the original owners will no longer be majority owners of the company.  Growth-minded owners must constantly grapple with whether they want 100% of a small company worth $1 million dollars or 20% of a billion-dollar company.  Serial entrepreneurs who have another company waiting in the wings to grow may not mind giving a majority percentage to investors or others, but those who have made their company their principal business and legacy, are more sensitive to the amount of the ownership percentage they maintain.

The growth-minded business person may feel the tradeoff of losing equity is worth it for the success the company will have, yet wouldn’t it be great to look at other options?   Enter phantom equity:  Phantom equity or shadow stock provides a tool for growth-minded business owners to give others a financial interest in their company without giving away equity.  The business owner can achieve success in retaining a greater ownership percentage yet still utilize a financial incentive to motivate high-performing employees, pay seasoned superstars in the field, investors or others.  Alas, they will have found that elusive golden ticket.

Next, we consider regulators.  According to the Securities and Exchange Commission (“SEC”), Phantom stock is considered restricted stock. This means that Phantom stock consists of  “unregistered shares of ownership in a corporation that are issued to corporate affiliates, such as executives and directors” and have conditions that must be fulfilled by the executives before the Company can transfer or sell the stock to them.[1] As noted above, Phantom stocks are a type of investment in the company that allows companies to provide its employees with a financial interest that emulates equity stock ownership in the company without issuing actual stock. This is where the description of “phantom” is derived. While this investment option does not provide true stock ownership, these simulated stocks do have monetary value that fluctuates with the actual value of the company’s stock.

Phantom stock provides profits to employees, provided the company stock itself generates profits, in a pre-determined length of time.[2] Due to this characteristic, phantom stock is considered a type of deferred compensation.[3] This deferred compensation, however, does not require businesses to issue Phantom stock to be issued in a certain way.  Rather, it is governed by contract. The terms and conditions of issuing this stock are listed in an agreement called the plan charter. The plan charter is where companies explain the vesting schedule to a stakeholder.  It sets forth a pre-determined goal that must be accomplished over a period of time in order to earn the right to this benefit.[4] The ability of companies to draft charters as they wish, provides them with great flexibility to follow employee-specific variables and metrics.

For example, if a Google employee received a benefit plan of 100 phantom stock on October 1st, 2016, and each share was valued at $1,000.00, their total value of the employee’s phantom stock would be $100,000.00 on that date. The pre-determined length of time established that the vesting period ended on January 1st, 2022. Suppose the employee decided to redeem this profit on January 1st, 2022, when the market valued the stock at $2,000.00. Then the employee’s total profit for the originally issued 100 phantom stock would be $200,000.00.  In this example, it’s important to note, the employee has no equity in the company, does not dilute the existing stakeholders, yet the employee stakeholder does receive the financial benefit.

The above is a simple example of a company utilizing “Full Value” phantom stock. A Full Value plan is one of the phantom stock plans that businesses can opt for. The Full Value plan allows employees to redeem the profit of their phantom stock at the full value of the market value at the end of the vesting period.

Man illustrating a rise in profits with is finger and transparent touch screen

III. Who Can Be Awarded Phantom Stocks?

The next question arises, “Okay, great.  Phantom stock looks like a wonderful option, yet who is it available to?”   We’re glad you asked. According to the SEC rules regarding restricted stock, phantom stock can be awarded to employees, independent contractors, directors, and consultants.[5] The difference in how each group receives this depends on how companies grant this stock. The plan charter for employees may list phantom stock as a benefit the company gives to the employee. On the other hand, independent contractors, directors, and consultants can only receive phantom stock if they list the phantom stocks as a form of compensation for their services.[6] Phantom stock awards are not limited to just corporations;  partnerships and LLCs can also grant these types of awards.[7]

IV. How is Phantom Stock Taxed?

Woman showing clipboard document to be signedNow that we know how phantom stock works and who is eligible to receive it, the next question businesses need to address is what are the tax implications and how should businesses structure this compensation to best meet their needs. The taxation of phantom stock depends on when the stock can be cashed in for a financial payment, commonly referred as to “when the phantom award vests.”[8] Because awarding phantom stock does not transfer shares or property, the phantom stock is not taxed the same way other income is.  Once the award vests, the employee will be taxed according to the Federal Insurance Contributions Act and Federal Unemployment Tax Act.[9] The vesting date is not necessarily the payment date. For employees, income tax withholding is due based on when the income is realized. This will not apply to individuals who are not considered company employees.  However, always talk with your CPA about your specific tax requirements.

V. Differences between Phantom Equity and Profit Sharing/Normal Stock

woman having a group meeting online with fellow employeesThere may be skeptics among us who say, “This sounds great, yet what is the difference between phantom equity and profit sharing?  It looks similar.”  The difference is that phantom stock does not dilute the company stock and will not grant an equity interest or voting rights to recipients.

Generally,  profit-sharing involves an immediate issuance of stock to the individual. This stock is usually nontransferable and forfeitable until vesting conditions are satisfied. Sometimes profit sharing immediately grants voting rights and equity to those awarded stock in the company.[6] On the other hand, those who are awarded phantom stock will not be able to gain any equity interest or voting rights and the company stock will not be diluted. Employees who receive this award only profit when the company does well in the market and the stock gains value. Once the stock vests and is awarded, then the employees receive a profit when they sell their stock.[6]


VI. Cross-Border Differences in Phantom Equity

Phantom stock is not exclusive to companies in the United States.  Companies should also consider what it looks like in a cross-border context. Phantom stock has become widely used in several European countries.[10] Canadian businesses have also used Phantom Stock as benefit plans.[11] Because each vesting period varies depending on the plan charter, cross-border taxation also varies. Make sure to contact legal counsel and your cross-border accountants for a consult regarding your specific plan charter if you are using phantom stock at the international level

VII. Conclusion

While Phantom stock as an idea has been around since the 1990s, companies are now giving it a fresh look so employees and companies alike should be familiar with how it operates. The intended benefits of phantom stock, such as providing more flexibility, offsetting equity dilution, and promoting employee motivation and longevity, have all proven phantom equity to be a highly effective strategy for improving company performance and aligning company goals with employee goals. Employees and companies should review their current benefit plans each year and explore what phantom stocks can offer beyond typical profit-sharing benefit plans.

Growth-minded owners can offer phantom stocks to overcome the challenge of providing a financial interest to others that will help grow the business while still holding on to that golden ticket called equity.  Companies using phantom stock can scale them to their dreams and leverage superstar talent without breaking the bank or losing their hard-earned ownership.  For additional questions feel free to contact legal counsel, Atty. Nouvelle Gonzalo at [email protected].  Our team would be glad to assist.

About the Authors

nouvelle gonzalo - Gonzalo LawNouvelle L. Gonzalo, Esq. is a magna cum laude graduate of New York University, an honors graduate of the Ohio State University College of Law, and was a visiting scholar at St. Anne’s College at Oxford University in Oxford, England.  Atty. Gonzalo is a U.S. and international corporate lawyer who works with companies across the globe. She is the managing attorney of Gonzalo Law, a U.S. and international corporate law firm with offices in Florida and Ohio and will open additional offices in New York, London, and Singapore. In addition to the active practice of law, she served as adjunct faculty of international corporate law at the University of Florida, Levin College of Law for three years. She is recognized with the top 2.5% of Florida lawyers as a rising star by the national organization, Super Lawyers from 2019- 2022. Her practice areas include: U.S. corporate contracts and acquisitions, international corporate law, and intellectual property     law.  Atty. Gonzalo can be reached at [email protected] or via phone at 855-466-9256.

Macarena Bazan Macarena Bazan is a recent graduate from the University of Florida with a double major in Political Science and Business Administration, specializing in Pre-Law. Macarena is the Executive Administrative Assistant for Gonzalo Law, a U.S. and International Corporate Law Firm. Additionally, Macarena is a rising first year law student at the University of Miami School of Law. She placed 3rd in the National Phi Alpha Delta Mock Trial competition and received the President’s Honor Roll and Dean’s List throughout her college career. Macarena has been with Gonzalo Law since January 2020. She focuses on case research, drafting and editing contracts, and executive administrative tasks.


[1]U.S. Securities and Exchange Commission, Rule 144: Selling Restricted and Control Securities., (Jan. 16 2013),

[2] UpCounsel, Phantom Stock: Everything You Need to Know, (Jul. 8 2020),

[3] Internal Revenue Service, Nonqualified Deferred Compensation Audit Technique Guide, (Publication 5528, 2021).

[4] Thomson Reuters Practical Law Employee Benefits & Executive Compensation, Equity Compensation Awards: Overview, (2022).

[5]SEC, Conn’s Inc. Non-Employee Director Restricted Stock Plan, (Exhibit 10.2.2, 2020)

[6] Ibid.

[7] Paolo M. Pasicolan, Demystifying Phantom Equity, Jul. 7, 2017),

[8] Thomson Reuters Practical Law Employee Benefits & Executive Compensation, Equity Compensation Awards: Overview, (2022).

[9] Paolo M. Pasicolan, Demystifying Phantom Equity, Jul. 7, 2017),

[10]Zattoni, Alessandro, Stock incentive plans in Europe: empirical evidence and design implications, (Corporate Ownership and Control 4ed. 56-64, 2007).

[11] Jacqueline Luffman, Taking stock of equity compensation, (Perspectives on Labour and Income 4.3ed 16-23, 2003).