Phantom Share Schemes: An Overview and Comparison with Traditional Share Incentive Schemes

As companies sharpen their focus on employee retention and alignment with long-term value creation, phantom share schemes are emerging as a standout alternative to traditional equity-based incentives. In an era where flexibility, control, and capital efficiency are more important than ever, especially for founder-led or privately held businesses, these “shadow equity” schemes offer a smart, low-friction solution to motivate top talent without giving away significant equity or control of a business.

What Are Phantom Share Schemes?

Phantom share schemes are, broadly speaking, incentive arrangements that are designed to reward employees as a company’s value and financial performance improves over time, offering employees a cash payout based on the company’s performance, all without issuing actual shares in the company. These notional or “phantom” shares behave much like real equity in terms of financial upside but don’t come with ownership rights, voting powers, or a seat at the shareholder table.

For the employee, it enables them to share in the financial success of the company. For the company, it enables the founders to retain control and ownership of the business they created. It can be a win-win that’s rapidly gaining popularity in sectors ranging from tech startups and professional services to family-owned enterprises and private equity-backed ventures.

Why Companies Choose Phantom Over Traditional Equity

Traditional share incentive plans, such as stock options or restricted stock units (RSUs), grant employees real equity or the right to acquire it over time. While these plans can be effective, they often bring with them significant complexity: dilution of ownership, expansion of the shareholder base, regulatory compliance, and sometimes the unintended consequence of creating new decision-makers at the table.

Phantom share schemes eliminate these complications. First, there’s no dilution. Since no new shares are issued, existing owners retain their full equity, a critical consideration for founders or investors wary of reducing their stakes, especially in early-stage or tightly held companies. Second, there’s a clear separation between ownership and employment. Employees do not acquire voting rights or shareholder privileges, preserving governance control and keeping cap tables clean. Third, the reward mechanism is based on cash. Rather than issuing shares that may be illiquid or subject to future sale restrictions, companies pay employees a cash bonus when a triggering event occurs, such as a company sale, IPO, or performance milestone, making the payout process simpler and often more attractive from a tax and liquidity standpoint.

Trigger Events: When the Payout Happens

Phantom share awards are typically structured around specific trigger events. These might include a liquidity event (like an acquisition or IPO), reaching a predefined company valuation, or completion of a vesting schedule. When the event occurs, the employee receives a cash payment equal to the appreciated value of their phantom shares, aligning their financial reward directly with the company’s success.

Are There Any Downsides?

While phantom plans are powerful tools, they aren’t perfect for every scenario. Some employees may view the absence of actual ownership as a drawback, particularly in companies where equity is tied to prestige, influence, or long-term wealth creation. Additionally, since payouts are made in cash, companies need to plan carefully to ensure they have sufficient liquidity to meet these obligations when trigger events occur. From a tax perspective, phantom payouts are generally treated as income, which is straightforward but may not offer the same long-term tax advantages as capital gains from real equity in some jurisdictions.

Ideal Use Cases

Phantom share schemes are particularly well-suited to private companies that want to reward high performers without complicating ownership structures. They are an excellent fit for founder-led businesses, family enterprises, or startups preparing for a future exit but not yet ready to offer actual shares. These plans are also valuable in markets where legal or operational constraints make traditional equity awards less practical.

In today’s competitive talent market, companies need creative, practical ways to attract and retain top-tier talent. Phantom share schemes have the potential to deliver the financial upside of equity participation, without the administrative and ownership burdens that traditional plans often entail. By offering a clear link between employee performance and company value, they provide strong alignment with corporate goals, while preserving ownership control and simplicity. For many businesses, they’re not just an alternative they’re a smarter way forward.

To discuss this further, contact Jamie Tredgold

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This material is provided for general information only. It should not be relied upon for the provision of or as a substitute for legal or other professional advice.