Phantom stock is a contractual agreement between a corporation and recipients of phantom shares that bestow upon the grantee the right to a cash payment at a designated time or in association with a designated event in the future, which payment is to be in an amount tied to the market value of an equivalent number of shares of the corporation's stock.
Like other forms of stock-based compensation plans, phantom stock broadly serves to align the interests of recipients and shareholders, incentivize contribution to share value, and encourage the retention or continued participation of contributors.
[3] For startups, phantom shares can be used in lieu of stock options to provide prospective contributors to the success of the startup with a simple form of equity participation, since the phantom share grants can be tied to negotiated vesting schedules with the payout being tied to a change of control or liquidity event such as an IPO or acquisition.
Both the startup and the recipients benefit from the flexibility of the agreement and the minimal legal and tax filing paperwork involved.
Generally, phantom plans require the grantee to become vested, either through seniority or meeting a performance target.
Use of a "rabbi trust" may solve this problem in some jurisdictions; however, that subjects the payout to significant risk, such as not being protected from the company's creditors in the event of corporate bankruptcy.
Typically the Phantom Options are issued at a strike price equivalent to the fair market value of the company, resulting in no tax liability at issuance.