phantom equity best practice

August 28, 2022

by a searcher from Indiana University, Bloomington/Indianapolis - Kelley School of Business in St Paul, MN, USA

I am interested in acquiring a small, niche company. The key employee is threatening to leave if the seller does not give him xxx amount to compensate for his years of loyalty. I want to buy this company but am looking for someone with similar technical background as the lead employee and offering him equity in the company. I am not ready for cap table but would like to learn more about phantom equity How does phantom equity work? Any best practices? Thank you!

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Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

Phantom Equity is usually set up as an agreement that gives someone an ownership based on a trigger. As an example, you can give an employee a stock grant that is phantom, meaning it does not show up anywhere. However, if you ever decide to sell the company, that triggers that ownership to become vested and they then earn their percentage ownership of the company upon a sale. If you have Phantom Equity you can have a right to profit distributions or no right to them, all depending on how the agreement is set up. It is almost like a secondary compensation agreement with the employee. However, you retain full control over all of the stock and decisions of the company. I hope this helps.

Reply by a searcher
from University of Illinois at Urbana in Chicago, IL, USA

Are they actually wanting equity? Or just more money? I'd also dig into if the company/equity had been offered to the employee. Equity gets really complicated. I think it can make sense if they are willing to pay in and have skin in the game, but even that can be tricky. It may be easier to adjust their comp plan such that if they hit some easily acheived quotas, they get a nice bump. It incents them to stay invested at least for the short term, while you weigh the longer term options.

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