When selling, or planning to sell, a professional services firm, it is important that the key personnel who are crucial to the on-going performance of the company are aligned to the majority shareholders’ exit goals. Without this alignment, they could be a less potent force in making those goals happen. Consider phantom shares as an alternative to employee share plans, in order to get that alignment in place.
What are phantom shares?
In simple terms, phantom stock does not include any real stock, it is like a cash bonus plan linked to the success of the company, where the timing, magnitude and phasing of the payout is determined by the deal terms you get in a liquidity event, such as your firm being acquired. Just like other forms of stock-based compensation plans, phantom stock serves to align the interests of recipients and shareholders, but without the same level of cost, complexity, and risks associated with a share scheme.
The pros and cons of a phantom stock plan
Choosing between real or phantom equity can be difficult (read the full article on phantom shares for a list of pros and cons). Adding real shareholders to a closely held company usually delivers much more holistic alignment of interests, as opposed to phantom shareholders whose alignment is biased mainly towards cash gain. However the addition of real equity owners brings the risk of a disagreement at the most important times in the life of a company, such as the sale or merger of your firm. Shareholders may exercise rights to vote and dissent. Real equity works for owners whose philosophy is for long term shared risk and reward with key employees and are prepared to manage the issues of having minority shareholders. Real equity may also be used as part of a shareholder succession plan, enabling you to fully or partially de-risk.
There are common situations where phantom shares may be the most convenient option, such as:
An opportunity to sell your company arrives before you got around to a real equity sharing program. There isn’t time to implement one, but you do want to reward some key people who have helped you build the business. You could quickly award phantom shares before you get into the sale process with the buyer, thereby providing justifiable reward when it closes.
You may have a management team layer of, say, 10 people below the shareholders and you want to get them on board for a 3 year grow and sell project. However this is a large team, with a diverse set of aspirations, loyalties and interpersonal relationships. You know that implementing real equity participation will be risky. Under these circumstances a phantom share plan may be the best solution.
Summary and key take-outs
Providing long-term compensation to key employees will get better employee alignment with your value growth and equity realization objectives. Buyers of knowledge intensive business, where the assets are largely intangible, need retention of people after acquisition. Real equity share schemes are most often used as the motivation and reward vehicle, however these come with risks. Utilization of phantom shares provides a lower risk alternative which may work better under certain circumstances.
Are you considering the future sale of your company?
If so and you would like to discuss your situation, along with motivational structures and options to better meet your valuation and exit goals, then we would be happy to discuss, so please call or email firstname.lastname@example.org for a meeting.