The Very Real Promise of Phantom Equity
The term “phantom equity” might sound intimidating, but it can significantly benefit your agency, especially when selling it. The advantages are substantial, so it’s worth understanding how phantom equity works. By leveraging phantom equity, you can secure the commitment of key employees to your agency for the long term, even after a sale, by offering them profit shares as an incentive. This strategy can act as the glue that binds essential human capital to your agency, ensuring its continued success.
What Is Phantom Equity and Why Does It Matter When Selling Your Agency?
Phantom equity is both equity and not equity. It offers the benefits of company stock without actually issuing any. Known also as “phantom stock” or “virtual shares”, they offer deferred compensation in line with company performance. And much like actual stock, this equity will vest over time according to an agreed schedule. However, unlike actual stock, phantom equity never offers the opportunity to exercise a voting right; they are financial-only. This means holders of phantom equity don’t sit on the cap table, carry no liability and, as such, pose practically no added legal requirements or costs to get set up as phantom stockholders.
Should I Take Advantage of Phantom Equity When Selling My Agency?
If you are considering selling your agency and you’re an owner who is looking to stay on long-term, phantom equity makes perfect sense. Phantom equity ensures that a founder – or any other essential team member for that matter – stays on, stays committed, and stays a part of the continued growth story even after a sale and post-sale transition period have been completed. Offering phantom stock in the business post-transaction offers an objective guarantee, aligning buyer and seller incentives for continued success.
After all, human capital is the backbone of any agency. It’s vital for keeping the agency operating at its best and ensuring its growth trajectory continues. This is especially true for smaller agencies with around 15 employees or fewer, where each team member’s contribution is amplified. Securing these key team members for the agency’s long-term success can be a mutually beneficial strategy.
When Does it Make Sense to Avoid Phantom Equity?
If you’re considering selling your agency and don’t intend to remain involved for an extended period, phantom equity may not suit your needs. Even committing to a full year post-sale may not align with the purpose and typical vesting schedule of phantom equity. In general, it requires a minimum three-year commitment for phantom equity to yield significant benefits.
In addition, if a buyer only wants to incentivize team members that stick around for an agreed minimum period that extends beyond the start of the vesting schedule, they may want to consider a cash bonus plan instead. The reason here is that these are generally forfeited altogether when an employee leaves whereas the vested phantom equity could mean having to pay out somebody who left sooner than a buyer might have liked.
The Bottom Line
The initial post-sale transition period of typically 90 days is tied into every deal. What happens beyond that is down to the interests and alignment of seller and buyer. If the interest is there for a seller to stay on board long-term and keep reaping the benefits of an agency’s ongoing growth story, the direct path to participating in the profits to come, is phantom equity.
