Here we are again, CARRILLO'S CORNER OF BUSINESS LEGAL EXPERIENCES mirrors on practical ideas, or useful hints for your day-to-day business. Today we are talking about participations called in "management circles" as phantom shares.
I warn you that I am no friend of what the R.A.E. (Royal Spanish Academy) defines as superfluous Anglicism’s, which are increasingly used in Spanish language; but I am keeping the title of this post as such, for easy identification on the Internet.
What are synthetic equities or phantom shares?
Phantom shares are nothing but a variable remuneration system or plan for external professionals or managers. This is different but simultaneous with the actual remuneration (commercial or labour, as the case may be), which the professional or labour manager receives for the provision of his or her commercial or labour services.
As a matter of facts, this feature is an Anglo-Saxon "invention" that quite interestingly fills a gap that existed in view of the need either to attract talented people to the initial cash-strapped projects, or to increase the loyalty of managers or external people, as the typical bonuses no longer seem to be enough.
Key takeaways: imagine a pyramid representing the different possibilities with which a manager relates to his or her company and its compensations, with the base being the lowest and the top the highest. At the top, we would find the condition of PARTNER, in a greater or lesser percentage. At the base (the lowest), the fixed salary for life.
Climbing up the pyramid, above the fixed salary, we would have variable remuneration based on objectives, profit sharing, etc. .....
Phantom shares are a way to benefit or retain the best managers or professionals without making affecting the actual ownership or transfer of any shares..
However, in recent years, employers are more and more seeking for new ways to give value or retain their best managers or professionals. As I mentioned before, the typical bonus seems no longer enough... But of course, no businessman wants to go to the extreme of making these workers or professionals partners. The latter is far easier and more frequent in listed companies, but difficult to assume in family businesses, as these structures already do face enough problems with their family-bound partners.
So, how to work out a plan for rewards that gives selected employees (senior management) many of the benefits of stock ownership without actually giving them any company stock?
Fundamental rights of the partners of a company
Being a partner in a company entails (in short) two fundamental rights.
Political rights (represented above all by the right to vote).
Economic rights (represented by the right to dividends and the right to obtain gains from the sale of shares).
Subsequently: If you want to confer your upper management, something that gives the same or similar economic rights as the ones related to a shareholder, but – here’s the key! - without granting any political rights, since they are not a shareholder in any way, then a phantom stock plan is the appropriate formula.
Actually, this is the origin of these shares, the so-called phantom shares.
This "bonus" or remuneration plan underlies to a contract signed by the parties. Sometimes the incentive is part of the senior management employment contract or of the contract for the leasing of services of the external commercial collaborator. The terms included in this document do not have any inherent requirements or specific restrictions.
Here I offer some ideas:
Receivers of synthetical equity or phantom holdings, phantom share
The following may be recipients of the phantom share plan:
Senior managers of the Company, as defined in Royal Decree 1382/1985, of August 1st, which regulates the special employment relationship of senior management personnel;
Employees or executives (who are not considered senior executives according to the aforementioned regulation) considered as "key employees or executives" for the Company, either because of the responsibilities attributed to their position or because they carry out their work in an area considered to be of special relevance for the main activity of the Company; and/or.
Any other third parties or collaborators. Individuals or legal entities whose contribution to the performance of the Company's main activity is considered to be of special relevance by the Board of Directors.
Compliance with Phantom Stock Plan in writing
The Plan is formalised in a contract or annex to the contracts. A copy of this plan may also be given to each beneficiary, as well as a letter setting out the specific rights and obligations of each beneficiary.
Economic rights of phantom shares or units
Beneficiaries may have any or all of the following economic rights:
A % of the value of the company, which will be equal to the amount realised from the sale, or, where appropriate, a value as objective as possible accrued at the time the beneficiary's right to receive it is agreed. This is the most common formula that gives selected employees many of the benefits of stock ownership, such as their participation in the value increasing of the company. It keeps them highly motivated towards a diligent performance as a senior manager. That is the ultimate purpose of this plan.
An agreement stipulating that the beneficiary will be entitled to an annual remuneration based on the percentage of phantom shares in relation to the results (say dividends) is also feasible, but frankly speaking, less common.
Political rights of shares or phantom holdings
It is not necessary, but I personally recommend to set-up a written agreement in the aim of clearly establishing that the beneficiary will not acquire any ownership, possession, usufruct, economic or political right over the shares that serve as a reference for the calculation of the corresponding remuneration, nor over any other shares that make up the Company's share capital.
Obligations of the beneficiaries
It is usually agreed that the beneficiary will be entitled to these phantom shares or units, provided that they meet certain objectives. These are usually temporary (e.g., permanence in the company for x years to guarantee loyalty) or the fulfilment of economic objectives, such as the amount of sales, profits, Ebitda, etc.
Consolidation
I suggest agreeing that the rights granted to the Beneficiaries will be subject to a vesting period. This will serve to schedule, where appropriate, the rights and the remuneration to be received by each of them.
Thus, it is usually agreed that the Beneficiary will accrue periodically (e.g. annually or half-yearly) x % of the attributed rights, the vesting of which will be determined throughout a certain number of months.
Assessment of vested rights
Here we refer to the date on which the vested rights are collected by the beneficiary, and thus paid by the company.
There are many scenarios. The most common ones are:
Total or partial sale of the company.
Decease.
Retirement or disability of the beneficiary.
Sometimes it also includes cases of unfair dismissal.
I highly do recommend a regulation of the payment method of the amount that the beneficiary is entitled to receive.
Commonly, an agreement stipulating that all rights are lost and therefore nothing will be paid in cases of voluntary leave or fair dismissal is fixed.
Contact our Legal Advice Department, our experts can help you to set-up this comprehensive instrument, accurately. It is being used more and more as it allows to link professionals or managers to the business project. Furthermore, it does not entail any periodic disbursement or cash flow problems, unless a payment for the above reasons is fulfilled. No doubt, this feature can be very useful for start-up companies which do not have the cash-flow to pay high salaries of qualified people, but aim for attracting talent to these initial projects with other mechanisms that sometimes suppose a higher risk.
Interesting...
Get more information by listening to our podcast in spanish on the subjects: Shareholders' agreements, phantom shares. In this podcast we also deliberate about the topic of shareholders' agreements. You can find us on all platforms by searching for PodcastbyCarrillo. We are on Ivoox, Amazon Music, iTunes Podcast, Spotify and Google Podcasts, as well as Youtube. Feel free to subscribe to receive our updates, we’ve got you covered!
