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ESOP vs. Phantom Stock – A Better Method of Employee Ownership

By Generational Equity

esop vs phantom stock

One of the more popular methods of retaining and motivating employees has been the creation of employee stock ownership plans (ESOP). These have been used for years as a method to allow business owners to both eventually cash out of their holding in a privately held company while at the same time providing a method to create an ownership mentality among employees, with a secondary goal of retaining them longer term.

The major drawback with this method is that instead of having one owner, you now have a cadre of owners, which makes key business decisions even trickier. And, ultimately, after creating the ESOP, should you decide to sell the company to an outside buyer, you now have a second set of owners that will need to approve the sale.

We encounter clients regularly who do not realize the ramifications of the various programs of providing stock to employees. In fact, recently, we had a client who wanted to go to market but he had 17 shareholders, all employees, who needed to sign our engagement agreement. Not only would that be a challenge, but the real issue is that suddenly a very confidential process would be made public. A far better method to use if you are interested in motivating, retaining, and giving your employees an ownership mindset is the use of “phantom stock.”

Phantom stock or phantom equity is a method that allows you to give your employees shares of non-voting stock, which they can redeem later, usually when the company is sold or when the employee retires (assuming the employee is fully vested). Unlike traditional shares that need to be repurchased when an employee leaves or is terminated, phantom shares “essentially disappear upon certain triggering events.”

Generational Equity does not provide tax and stock structure advice. Before you consider doing any sort of stock sharing plan, you need to consult your CPA and attorney. While talking with them, bring up the subject of phantom equity as an option. It is not widely known and has many benefits.

One of the biggest benefits of creating a phantom stock program is that it is far less costly than creating an ESOP. And, since these are non-voting shares, you can still make key decisions without getting the approval of your employees.

Be Sure To Plan Ahead

Again, we are not experts in the creation of phantom stock programs or ESOPs. We are experts in finding optimal buyers for privately held companies and we have seen the challenges that stock ownership programs can cause when buyers begin to officially look at a company.

Since we believe that business owners need to fully understand the potential ramifications and negative impact of having employees involved in the decision and approval of a business sale, we hold complimentary, no-obligation exit planning seminars that outline the most effective and efficient methods of releasing the equity in your business and making you liquid. While there you will be introduced to the latest information on exit planning and have the opportunity to meet with one of our M&A professionals who can discuss your particular situation.

To learn more, browse our website. But no matter what you do, please consult with objective experts on the benefits and risks of any stock ownership plan.

Carl Doerksen is the Director of Corporate Development at Generational Equity.

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