(b) In general, phantom stock is merely a promise by the company to pay a bonus in the future, usually based on increases in the equity value of the company. This provides the upside opportunity to the management team, which is enjoyed by the shareholders in a liquidation event. The valuation is ideally set by an initial appraisal of the company (and updated every year), or else by a formula determined by the company’s board. The plan valuation formula should be interpreted and the new share price determined and validated by company officers. For purposes of the following illustrations, assume there are 90 units, which represent 90 actual shares of stock outstanding, and 10 phantom units that are available for grant under the phantom plan. Using actual shares outstanding requires paying careful attention to internal share transactions. The phantom stock is not actual equity; however, it is tied to the value of the company's stock. Pros and Cons of Phantom Stock. A company may award annual shares for a number of years to a changing group of employees. This ensures the appreciation in value is resulting from earnings growth, not changes in the environment over which the executives have no control. The value of the company can be established by a variety of means, including: Stock exchange (for public companies) For stock option plans, the Black-Scholes approach is most commonly used. The valuation formula is set forth in the phantom stock plan. A phantom stock plan, or 'shadow stock' is a form of compensation offered to upper management that confers the benefits of owning company stock without the actual ownership or transfer of any shares. There are three basic approaches to establishing the value of phantom units, which are also common methods to value actual shares, for example, subject to buy/sell agreements: This approach requires the company to retain the services of an independent appraiser or firm. This method eliminates the need to track adjustments to the company’s actual share count. A phantom stock program is a deferred compensation plan that grants employees the benefits of stock ownership without actually giving them any company stock. Designed properly, phantom stock plans share the value growth of the business with the phantom stock plan participants in much the same manner as the equity shareholders share the growth. The approach used for valuation should take into account adjustments that the parties agree are appropriate. Once these two answers are known, the phantom share price is calculated as the former (the value) divided by the latter (the number of shares). The units will represent a percentage of the total value of the company. Closely- Nonetheless, utilizing actual share count can lead to confusion and an unfair result for shareholders or plan participants. To receive more complimentary information about Phantom Stock from our expert advisors, please provide us with your contact information below. In private company situations, equity value may be further reduced to reflect discounts for lack of marketability and/or control. Appraisers will often use a number of methods to determine value and may include both intrinsic and extrinsic factors in the determination of value. It is important that the plan treat the phantom shareholders fairly. Customarily, they have observed transactions within their industry and are aware of key indicators and multiples. Or it could promise to pay her an amount equal to the value of a fixed number of shares set at the ti… Accounting Treatment for Phantom Stock Plans An annual valuation needs to be completed at the year-end to determine if there has been an increase in value in accordance with the phantom stock plan’s formula. Design of a phantom stock plan can replicate the value of real stock. Carefully consider how to address delivering value to the phantom shareholders when actual dividends are paid to the equity shareholders. There are three different ways to award phantom stock: 1) Full value grant. This approach is used when the company desires to keep the value of real shares and phantom shares equal (using the same formula). This results in a “value dilution” potential of 9.1% (100,000 ÷ 1,100,000). If the shareholders desire not to share dividends with phantom shareholders, the plan can be designed to share growth in enterprise value rather than equity value. TEXAS OIL & CHEMICAL CO. PHANTOM STOCK PLAN 1. –Phantom stock –Stock ... 9where the valuation is based on a buy-back formula ... (In other words, if a buy-sell formula applies to all transactions involving the company’s stock, then the buy-sell formula can be used to value stock as of a given date) 22. How Phantom Stock Plans Work. This is a better way to track value dilution than counting shares. It is more important to track the percentage of value shared under a plan than it is to track the percentage of shares. Thus, each phantom unit is equivalent to one percent of the value of the company. This is a plus, as the value rendered should most certainly reflect a fair value; however, extrinsic factors are often not under the control of the executives in the plan and may reward or penalize the executives in the value of the phantom stock compensation. Phantom stock plans have become very popular among private companies as a way to engage senior management, generally those who don’t have any actual equity ownership, in the value proposition of the business. 4. There are two kinds of phantom stock plans that a company can choose from: The “Full value” plans where the complete value of the share is offered, including the value of the underlying shares and the appreciation. Redemptions of stocks or transactions between shareholders could alter the number of shares outstanding and affect the value of phantom shares even though these transactions are not related to employee performance. 4. Long story short: You can’t offer equity without knowing how much a share is worth. For example, when buy/sell agreements use the same formula used for the phantom plan. This approach requires a circular equation and, thus, it is more complex. The company should schedule a company valuation and construct a formula that will determine the stock's value each year. These entitle the holder only to a payment at a liquidity event equal to the increase in value of the LLC (based on a number of units) measured from date of the award to the date of the liquidity event. The formula above solves for value of actual equity and assumes the phantom plan is a liability of the company that reduces equity value. The value of phantom stock units is measured by the value of the company stock. As the Formula Value approach is most common, it is described below. Lock in or fix the multiple to be used to calculate enterprise value. An award of phantom stock is a promise to pay an amount equal to the value of one share of company stock. The averaging may be weighted on most recent earnings or a simple average may be used. If the value increases then an accounting is recorded as compensation expense together with the liability for future payment. What does phantom-stock-plan mean? Book value relies on stockholders’ equity set forth in the company’s financial statements to represent the value of the company. For these reasons, the possible market multiple value would usually be discounted. Book value may or may not be representative of a true fair value for the company, but it is easy to measure and does a good job of sharing profitability with the phantom shareholders. Book value does not necessarily reward for growth in value, however. Thus, the payout will increase if the stock price rises, and decrease if the stock falls, but without the recipient actually receiving any stock. Phantom Unit Valuation. Unitizing the plan in this manner makes the math simpler. Under a stock grant or SAR, the general concept is that the executive will be rewarded by the increase in value of the ownership shares allocated at the date of the company sale over the value on the date they were issued. Perhaps you want to incentivize a salesperson for your company. Calculate EBITDA before the phantom stock plan expense. The Board needs the flexibility to make adjustments in unusual situations. Phantom stock is simply a promise to pay a bonus in the form of the equivalent of either the value of company shares or the increase in that value over a period of time. Appraisals can be expensive and using an outside appraisal may delay closing the books at the end of the year, since the current updated values are needed to adjust the company’s phantom stock liability each year. This approach requires the company to retain the services of an independent appraiser or firm. time, typically tied to a valuation formula. Examples of phantom stock include: • “Phantom” stock plans. Give employees shares valued in full at the price you established in your valuation. The appraiser provides an opinion as to the valuation of the business, which is then used to determine the value of the phantom units. Based on that multiple, you could create 5,000,000 phantom shares at $10 per share, for a total valuation of $50,000,000. This is because not all shares are commonly issued at the same time. One of the key considerations is the valuation of the business. The answer involves two variables: (a) the presumed value of the company, and (b) the number of shares to be used in the plan. You give your salesperson units of phantom stock and each unit has a value of $10 based on the then value of the whole company. Average the EBITDA over a number of years, generally three, to reduce the volatility of the values produced. Phantom Stock. The number of shares to be allocated to employees simply becomes a fractional sub-set of the available hypothetical shares. © Copyright 2021 Findley, A Division of USI, -40 (based on unit value resulting from calculation). In some cases, it makes sense to limit the addition of cash balances to situations where the company has adequate working capital. A phantom stock share is an unfunded bookkeeping unit, entitling the Employee to payment of the appreciation in value of the phantom stock share. It is widely applied in all areas of finance. How does a company establish the price for phantom shares? Private companies usually use one of the other three approaches. Examples of extrinsic factors that may impact the valuation include interest rates, competitor consolidations, and shortages of natural resources. This valuation determines the cost to purchase a share. Provide for a substitution of actual value (rather than formula value) if the company is sold. Reserve the right for the Board to make adjustments for extraordinary gains or losses in determining EBITDA. For example, the Formula Value could be expressed as “6 times net income minus long-term debt.”. To learn why sharing value with those who drive growth is so critical to your pay strategy, download and read our report today! For example, if the assumed multiple value is “6 times net income,” for purposes of the plan Formula Value the company may use “5 times” or even “4 times.”, Further adjustments may be made to account for the level of long-term debt within the company. Designing phantom stock plans can be tricky. This formula drives the company’s stock price higher as well. For example, if employee “A” were to receive 1,000 shares of phantom stock, with each stock worth $20, the current value of the company stock would be $20,000. However, the company would not typically use the formula that might represent actual market conditions. The typical discounts are a lack of marketability discount or a minority interest discount. • Restricted stock units (“RSUs”) are phantom stock awards subject to vesting conditions. The most theoretically sound stock valuation method, is called "income valuation" or the discounted cash flow (DCF) method. Ongoing adjustments can counter-act these events. Phantom stock is an employee benefit where selected employees receive benefits of stock ownership without the company giving them actual stock. Phantom Stock Plans can vary in their terms, but usually have two components: A share of annual net income (Profit Share); and, A stock appreciation right (“SAR”). A valuation expert can use limited valuation discounts in determining the value of a share of stock. The amount of compensation delivered to a phantom stock plan participant is based on the number of units he or she holds and the “phantom unit value” or “unit value.” In most plan designs, a maximum number of phantom units will be established in the plan. The value of the company’s stock or the appreciation in the value of the stock after the date of the phantom stock award determines the amount of compensation. The value used for determining compensation to be paid may be determined by an arbitrary formula based upon the company’s performance or derived from a third-party valuation of employer stock. This approach is simplest and treats the phantom units on par with the real shares. The company should keep track of the dollar amounts owed and payable to employees and evaluate this amount relative to the increase in the company value since the date of plan inception. There are effectively two ways to handle the number of shares for the plan: (a) actual company share count (shares outstanding) or (b) hypothetical share count. Just like real stock, the shares are worth money and rise and fall with the value of the company. An alternative approach is to use a hypothetical share count. This approach is used when there is no desire to keep the value of the real shares equal to the value of the phantom shares (although they will be close). Some companies use their actual shares outstanding and “issue” new shares for the plan. The award is usually contingent upon the phantom A 409A is an independent appraisal of the fair market value (FMV) of a private company’s common stock, or the stock reserved for founders and employees. There are three basic approaches to establishing the value of phantom units, which are also common methods to value actual shares, for example, subject to buy/sell agreements: Appraised value; Book value; Earnings formula; Appraised Value. Here's how phantom stock plans work: You give your executive 1,000 shares of so-called phantom stock at, say, $10 a share.The phantom stock … The phantom values are determined based upon a formula in the plan, which happens to track closely to the actual value of the share price. In this case, special adjustments must be made to offset the value of significant capital investments made by the company since there are no debt offsets. When dividends are paid, the company has less cash to pay down debt or reinvest in the business, which may impact the valuation. The Formula Value should ultimately arrive at a value that can be easily calculated from the company’s financial statements and fairly represents underlying economic value. You either state a formula or schedule a valuation to determine the value of the company in the future. Dictionary ! That same $500,000 for the employees, paid out as a phantom stock compensatory bonus, would be taxed at ordinary rates. The shareholders might approve an additional 100,000 phantom shares. If the valuation formula shows that the company’s stock has risen by $20 a share, the executive would receive a $40,000 check. It is worth money just like real stock, and its value rises and falls with the company's actual stock (or what the company is valued at, if it's not a publicly traded company). This article will review and discuss the valuation issues common in designing a successful phantom stock plan. Contact Us Todaydocument.write(checkCookie()), © 2019 - PhantomStockOnline.comPowered by VisionLinkAll Rights Reserved, Formula value (such as a multiple of earnings). Adjustments may be made for other elements as well (cash, net equity, etc.). Enterprise value is then reduced by bank debt and increased by cash balances to determine equity value. Menu ... A formula is developed to determine the phantom stock’s value. This calls for the random selection of a number of shares to be used for the plan, such as 1,000,000 or 10,000,000. Phantom stock (also commonly referred to as “shadow stock”) represents an If paid in cash, can be … ... Ready to Speak with a Phantom Stock Expert Now? Suppose Company A gives an executive 2,000 shares of phantom stock or hypothetical shares at $30 a share. The objective is to determine the total enterprise value, which is then shared or allocated between the phantom shares and the real shares. The value of the company can be established by a variety of means, including: A public company would typically use the actual share price as determined by its listing exchange. Once the valuation is determined, the company may set aside 10% of the equity value, or 10% of the issued and outstanding shares or units, as phantom stock for distribution under the plan. There is no perfect formula to identify all unusual items and how they should be treated. What is the Valuation … This Phantom Stock Plan, (the "Plan"), of Texas Oil & Chemical Co. for a select group of management personnel is intended to advance the best interest of Texas Oil & Chemical Co. and subsidiary companies by providing such personnel who have a substantial responsibility for the management and growth of the … When the payout is made, the value of the award is taxed as ordinary income to the employee and is deductible to the employer. The factor, referred to as a “multiple”, will typically range from four to ten times EBITDA depending on the industry, the interest rate environment, the expected growth rate for the business, and other factors. Perhaps the most common fundamental methodology is the P/E ratio (Price to Earnings Ratio). The calculation of book value generally requires the use of a “circular” equation to solve for the book value of the units, which is treated as a liability (expense) under GAAP. 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. Since many, if not most, plans issue new awards periodically (perhaps annually), a process for determining and approving such grants should be put in place. For example, a steadily performing company with no growth in earnings may show nice growth in book value with little or no growth in actual shareholder value. The most common approach is to pay the phantom shareholders “dividend equivalent” bonuses or deferred bonuses. The unit value for the phantom plan is set equal to the unit value of the real shares. This is a form of compensation where a company promises to pay cash at some future date, in an amount equal to the market or formula value of a number of shares of its stock. For example, the plan may create 100 units of which 10 (10 percent) may be granted to phantom participants and 90 (90 percent) represent the interests of the real shares. Let's say under the terms of the agreement, the employee must stay with the firm for five years to benefit fully from the phantom stock deal. Those conditions may change and it is possible the company may one day sell for less than what the assumed market multiple is today. Since the total share equivalents (100 in this example) are used from inception, the allocation or grant of additional phantom units does not dilute the current unit holders. Allows employees to share in the growth of the company’s value without being shareholders. The components are usually based upon some type of vesting table that provides … For example, competitors may have sold to buyers for “6 times net income” or “5 times EBITDA” or “1 times revenue.” Such a formula may become the starting point for the discussion regarding the Formula Value. “Phantom Unit Appreciation Rights”, which are the equivalent of phantom stock appreciation rights in a corporation. deferred or incentive compensation which involves a promise to pay an amount to an employee at some future date Generally accepted accounting principles (GAAP) are the standard for determining value. The value may be stipulated, determined by an express written formula, or determined by appraisal. Ready to Speak with a Phantom Stock Expert Now?Call (888) 703-0080 or complete our contact form. Only in an event like this does the actual value of the company become known. To illustrate how to calculate stock value using the dividend growth model formula, if a stock had a current dividend price of $0.56 and a growth rate of 1.300%, and your required rate of return was 7.200%, the following calculation indicates the most you would want to pay for this stock would be $9.61 per share. Should the company distribute all shares to employees, shareholders would be reducing their equity value of the company by 9.1% (assuming Full Value awards). Payment may be made in stock or cash at a specified settlement date. For example, assume 1,000,000 outstanding shares in a given company. EBITDA formulas are common valuation formulas used to determine values for buying and selling company stock and can be effective in a phantom stock plan if a few design techniques are used: Once equity value for the company is determined, there are two possible approaches to calculate the actual unit value of the phantom stock units as illustrated below. The foundation of the Black-Scholes method is an option valuation formula that incorporates the firm’s stock price, the dividend yield of the firm’s stock, the option’s exercise price, the expected term of the option, the interest rate on risk free securities and the expected volatility of the firm’s stock. Keep the balance sheet adjustments for debt and cash straightforward. It generally makes sense to use a conservative multiple that does not change over time. For instance, a company could promise Mary, its new employee, that it would pay her a bonus every five years equal to the increase in the equity value of the firm times some percentage of total payroll at that point.
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