Phantom shares

What it means

Phantom shares, sometimes called virtual shares, are an incentive plan in which an employee or manager receives not a real stake in the company but the promise of a cash reward that tracks the value of a stake. The reward is paid, for example, when the company is sold, when a set value is reached or when dividends are paid.

The advantage is simplicity: the ownership structure does not change, the articles need not be amended, no new shareholders are entered in the commercial register and the employee gets no voting rights. For a Slovak s. r. o., where transferring a stake is administratively demanding, this is often more practical than a real ESOP.

The plan usually includes vesting, meaning a gradual entitlement to the virtual shares over several years, and rules for when the employee leaves. Some plans pay out the full value of the stake, others only its increase since the grant.

How it works in practice

For tax, a phantom share payout is employment income, like a bonus. The employer withholds tax and contributions and pays its own contributions. Unlike selling a real stake, no holding-period exemption applies.

In the accounts it is a liability to employees that builds up gradually. During the plan the company should set up a provision for the expected payout, or disclose a contingent liability in the notes, so that the result in the year of payment is not distorted by a one-off cost.

The agreement should specify exactly how the value of the stake is calculated: from the purchase price on a sale, otherwise for instance by an EBITDA multiple or an expert valuation. An unclear formula is the most common source of disputes between the company and its managers.

What to watch out for

The biggest risk is liquidity at the moment of payout. If the reward is paid on exit, the money comes from the sale price. If it is paid when a value is reached without a sale, the company must have cash for both the reward and the contributions, which add more than a third on top.

The second risk is departures. If the plan does not say what happens to entitlements when an employee leaves or is dismissed, a dispute over unpaid rewards can arise. Good leaver and bad leaver rules are best written into the agreement from the start.