Share incentive plans (sometimes called ESOPs) come in many forms. We will focus on two of the main types of plans, classic and phantom. Classic plans are the more traditional of the two and involve issuing actual shares in your startup to your employees, consultants and advisers. Phantom plans substitute issuing of actual shares with phantom or synthetic shares. These are basically contractual rights that aim to replicate the economic benefits of holding shares without issuing any shares (a phantom share is just a term to describe economic rights under a contract).
Clara Tip: We don’t take into account tax considerations here. Depending on the jurisdiction of your startup and where your employees, consultants and advisers live, there may be material tax considerations that impact the benefits and drawbacks of classic and phantom plans.
Key features of classic plans
Classic plans are the most popular and the one you are most likely to come across. Most people are familiar with the concept of a classic plan where shares are issued in the name of the recipient.
Benefits of a classic plan:
A familiar structure that parties will be more comfortable with.
Employees, consultants and advisers will feel a higher sense of ownership if they hold actual shares.
Funds on an exit likely to flow directly to the employees, consultants and advisers.
Drawbacks of a classic plan:
They involve a lot more time and cost (think having to gather KYC, make filings, update registers etc.).
As you scale, your cap table can get very cluttered with a lot of small shareholders.
Employees, consultants and advisers may be required to sign documents in case of an exit.
Key features of phantom plans
Phantom plans are a newer concept. They remain less well understood in most markets but can offer flexibility.
The key benefits of a phantom plan:
Much cheaper, quicker and easier as there are no shares to be issued, filings to be made or additional documents to be signed on an exit.
Allows you to keep a much cleaner and simpler cap table.
Still provides for the same economic benefits to plan participants.
The key drawbacks of a phantom plan:
More explanation is required to gain acceptance of replacement of actual shares with phantom shares.
The startup needs to track and record the phantom shareholders in addition to the shareholder register to maintain an accurate fully diluted cap table.
Your startup may have to administer and pay out large sums of cash after an exit.
TL:DR, here are 3 key takeaways:
You can structure your share incentive plan as either classic or phantom.
Classic is more common and might be an easier sell to your employees, consultants and advisers BUT it takes more time and money to administer.
Phantom is a less traditional structure that might require more explanation, as well as additional steps around the distribution of proceeds on an exit BUT it is a simple, quick and cheap way to keep your cap table tidy.