Phantom Stocks

ESOPS are a great method to reward/retain employees.

The governing framework is

• Listed companies : SEBI (Share Based Employee Benefits) Regulations, 2014 (SEBI Employee Benefit Regulations)
• Unlisted companies : Section 62(1)(b) of the Companies Act, 2013 read with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 (Companies Act ESOP Provisions)

What is Phantom Stock

A phantom stock plan is a deferred compensation plan. Also known as “shadow stock” or “ghost shares”, it gives employees the opportunity to share in the wealth and success of the company. Upon redemption of phantom stock, the plan participant receives cash compensation.?The gain mirrors the appreciation value of a share to an employee without actually handing over the shares.

Mostly, phantom stocks combine the features of employee stock options and a compensation program, making it a useful employee retention strategy. Phantom stocks involve cash-based payments.

Since the employees don’t end up owning stock, there is no threat of the employee selling the vested stock to the competitors. Its a preferred option for a closely-held company, which might not want to issue shares to employees and run the risk of disagreement among shareholders

Phantom stock plans are also flexible - an employer can discriminate in choosing which of its employees will participate in the plan

Companies are not required to make any cash outlay until an employee settles his account-a particular benefit for start-up companies

Types of Phantom Stocks

?Appreciation Only:

Under this type of plan, the employee receives the difference in stock price between the date of issue and the date of redemption. For example, if an employee is issued phantom shares in Jan 2022, when the price per share is Rs.100. He redeems the stocks when all the conditions are met in Jan 2023, when the price per share is Rs.180. In this case, the employee receives Rs.80 (i.e., the difference between Rs.180 and Rs.100) as a cash payment from the company.

Full Value:

Under this type of stock plan, on the date of redemption, the employee would receive the full value of the underlying stock. For example, if an employee is issued phantom stocks in Jan 2022, when the underlying share price is Rs.100. He redeems the stocks when all the conditions are met in Jan 2023, when the price per share is Rs.180. In this case, the employee will receive the full value of the stock price – Rs.180 as a cash payment from the company

Legal Framework

Companies Act 2013 is silent on the grant and exercise of SARs including issuance of equity settled SARs and Phantom Stock Options.

SEBI Employee Benefit Regulations will apply only if we are "dealing in, or subscribing to, or purchasing, securities of the company directly or indirectly". Hence they do not apply to Phantom stocks

Taxation

When the employee eventually receives the cash entitlement at the time of the exercise of Phantom Stock Options, the same is taxed under the head of salary income as perquisites in the hands of the employee. The employer gets a deduction for the same

Risk

The premise for phantom stocks is that they become more valuable as the business becomes more successful.?The employer must have cash on hand at the time of payout to pay the employees. If the share value decreases, the employer can terminate the deal or offer only a small amount of the total valuation.

If there is no subsequent funding round, the determination of value for calculating the appreciation can be in question.

Since employees dont invest their own capital, ithere is no skin in the game and thus little incentive to remain with the company if it does not perform well