EM Law | Commercial Lawyers in Central London
Phantom share options solicitors
Phantom share options are arrangements that allow individuals who are given the benefit of the options to receive a cash payment linked to the increase in value of the “real” issued shares in a company.
For example, let’s say that on 6 April 2018 a company’s ordinary shares are worth £1 million.
John Smith, an employee of the company, is a participant in the company’s phantom share option plan. The plan states that if the company’s ordinary shares are worth more than £1 million on 6 April 2019 each of the participants in the scheme are entitled to receive a cash payment of £1,000. On 6 April 2019 the company’s ordinary shares are worth £1.5 million. John Smith is entitled to a payment from the company of £1,000.
It is also possible to provide simple “phantom shares” where shares are linked directly to the value of a real share. To utilise the above example, John Smith is awarded 100 phantom shares, tied to the value of a corresponding real shareholding valued at £1000. If the value of those real shares increased to £2,000, John Smith would be entitled to a £1,000 cash payment.
Phantom share options are conceptually similar to share appreciation rights (SARs) which is the term more commonly used by US corporations.
Why use Phantom Shares?
One of the advantages of using phantom shares is that it obviates the need to issue real shares. This means that the employees who benefit from the phantom shares won’t need to sign off on transactions, aren’t entitled to attend general meetings and the balance of power between the shareholders who are issued with real shares is not disturbed. Think about it one way: two companies form a joint venture subsidiary, each company owns 50% shareholding and/or the voting rights. In that circumstance, it would not be possible to issue employees with shares as it would dilute the original arrangement between the companies. As neither company can go ahead and issue shares, then it is that much more difficult to incentivise employees to remain with an employer long term.
In many ways it makes it simpler for employees to participate in the growth of the company without the complexity and additional considerations that come with issuing real shares.
In the example above, John Smith is entitled to a payment when the company’s shares reach a certain value. However, phantom shares can be granted on an “exit only” basis i.e. when the company is sold. In this instance, if the company is bought for cash, liquidity should not be an issue.
Phantom shares can also be tied to a specific valuation formula. This is useful where a company held substantial appreciating assets or investments that it wanted to exclude from the employee’s renumeration. For example, where a company with a relatively limited number of shares held a significant property development portfolio, it may not wish to remunerate an employee in line with that exponential increase in value.
Accordingly, companies may want to place a cap on the value of the award, or have it payable in stages, to avoid a significant liability once the target is met.
There is no income tax liability on the grant of a phantom share option. An employee who receives a pay-out will be subject to income tax and NICs on the amount of cash received in the same way as any other cash bonus. Employer NICs will also apply.
The use of phantom shares also, in usual circumstances, avoids the requirement to file a share scheme annual return with HMRC.
Phantom shares need to be structured carefully bearing in mind the requirements of the Financial Services and Markets Act 2000. That Act regulates the use of alternative contracts which are tied to the value of property. But as the employee is not making an investment, careful drafting can avoid being caught by this regulatory provision.
For any questions you may have concerning phantom shares contact our solicitor Suzy Giele.