Comparing cash based incentives to legal share ownership
Real shares make the holder a legal owner of part of the company, with rights defined by the articles of association and any shareholder agreement, including voting and a claim on assets on liquidation. Phantom shares are a contractual bonus scheme where the company agrees to pay cash based on how much a notional shareholding would have been worth, typically at exit or another defined event, with no legal ownership created at any point.
- Shares can be sold, transferred or pledged, subject to any restrictions in the shareholder agreement
- Phantom shares cannot be transferred, sold, or used as collateral since they are not property
- Shares carry a claim on assets if the company is wound up, phantom shares generally do not
- Phantom shares are simpler to unwind since there is no share transfer or buy back needed
Trade offs between virtual units and real equity
| Feature | Phantom shares | Real shares |
|---|---|---|
| Ownership | No | Yes |
| Voting rights | No | Usually yes |
| Dilution to founders | None | Yes, immediately |
| Payout form | Cash | Sale proceeds or dividends |
| Typical tax treatment | Income tax on payout | Capital gains on sale, possible tax on acquisition |
| Admin complexity | Low, contract only | Higher, cap table and register updates |
Choosing virtual plans for control and simple admin
Phantom shares suit founders who want to reward key employees financially without giving up control or diluting the cap table before a fundraise. They also suit companies with a small number of controlling shareholders who do not want new voting parties. Real shares suit companies that want to align long term incentives with genuine ownership and are comfortable with the dilution and admin that comes with it.
A phantom share payout is a cash liability the company must be able to fund at the trigger event, so it should be modelled into cash flow planning ahead of any exit or liquidity event, unlike the mechanics of share grants.
Ownership versus a cash promise: what to ask
- Which is cheaper to set up?
- Phantom share plans are usually cheaper and faster to set up since they avoid share issuance formalities, but the company takes on a future cash liability instead.
- Do investors care about phantom share plans?
- Investors typically want to know the size of phantom share commitments since they represent a future cash cost, similar to how they review the option pool for dilution.
- Can a company use both at once?
- Yes, some companies grant real shares to founders and senior leaders while using phantom shares for a wider group of employees.
General information for founders, not legal or tax advice. Thresholds and rates change, so confirm the current position with an adviser in the relevant country before granting.