There are three things that can happen in your business that you want to make sure your key people stick around for. They are:
- You become seriously disabled.
- You die.
- You sell your business.
All three require your management team to stay with your company if you have any hope of holding its value. The first two issues are disaster-planning scenarios. The third is one that helps you maintain value in your company should you decide to sell it.
What is phantom stock?
Phantom stock is also known a synthetic equity. It acts in many respects like real stock, but it’s not. There is an economic value for your employees but there aren’t voting rights that come along with it.
A phantom stock program allows you to set any rule you want for who can get it, how it’s granted, and what sort of strings are attached. Many times owners will put phantom stock programs in place that create a sharing of values with senior management when the value of the company increases. This is called a stock appreciation rights program. It’s also my favorite form of phantom stock.
Why use phantom stock?
If you believe that at some point in your life you’re going to sell your company you need to have a system in place to share the reward with your key people. When you sell your company the buyer will be less interested in you than your key people. The buyer likely thinks that they can replace what you bring to the party (even though they won’t tell you this). The buyer also knows that without your key people it’s going to be very hard for them to integrate your company into their operations.
If you happen to die or become seriously disabled, your family and in some cases you won’t get much if any value out of the business if your key managers all decide to jump ship. Having a stay bonus in place will help your employees know there is a financial reward if they stick around and help the business get through a potential rough spot.
Remember the legal ramifications.
It used to be really easy to set up a stay bonus with phantom stock. Today, it’s more difficult and expensive. There is an IRS code section called 409(a) that speaks to rules around deferred compensation plans. Phantom stock fits into that description. You must have your plan vetted and clarified in writing by an attorney who is an expert in 409(a) planning. This is a very complicated part of the IRS code. If you don’t spend time getting it right, it could cause you and your key people real pain in the future.
Make it real.
Most people don’t fund their stay bonus programs. I think this is a mistake. If you intend to give a benefit to your people when you sell your company you should let them know there’s real money behind the program. When you fund a phantom stock program with cash as your company increases in value, your employees know there will be a benefit there, especially if you die or become disabled.
In most cases your stay bonus will agree to pay your employees for a period of time should a triggering event like the three listed above happen. If you also include a stock appreciation rights component, you are creating a retirement plan as well. Having cash in the plan will give your employees assurance that you’ve put real money behind your promises.
You will want your people to stick around!
The key here is if you have employees who are highly productive and are helping you make your company grow you want to have them stick around. Treating them well, showing respect, and listening to their ideas are all important things. It’s also important to have them know that you’re going to reward the economically for a career where they’ve shown loyalty and trust. It just makes sense.
We have a periodic table of business strategies you might be interested in. This table has various strategic activities you can use in your company to increase the enterprise and personal value of your company. To get this report, click on the button below.