For many growth companies, the challenge is how to share with employees long‑term value creation without the administrative burden, governance complexity and shareholder dilution that comes with issuing actual equity. Phantom share option schemes offer a pragmatic, high‑impact solution. If properly designed, they replicate the economic upside of share options, preserve cap table simplicity and allow employers to calibrate vesting, performance, leaver, and exit provisions with precision—while avoiding the issuance of real shares.
What a phantom share option scheme is
A phantom plan grants notional “options” or “units” that entitle participants to a cash payout mathematically linked to increase in company value over time. Participants do not become shareholders and do not acquire voting or other equityholder rights. Instead, on a defined trigger/ settlement event, participants receive cash that is equal to the positive difference between the fair market value at settlement and the grant “strike” price, multiplied by their vested units. These triggers or settlement events are commonly some sort of liquidity event (such as a sale or IPO) but companies can and do use scheduled valuation dates or periodic post‑vesting windows (to create certainty).
Because no equity is issued, phantom schemes deliver the economic characteristics of options without dilution, share issuances, or shareholder agreements. They are typically documented through a board‑approved plan (shareholder approval is unlikely to be needed) and individual award agreements that specify grant size, cliff, vesting, performance conditions, settlement mechanics, valuation methodology and leaver/ bad faith/ clawback provisions.
Why phantom schemes are attractive
The principal attraction of phantom schemes is the combination of alignment and simplicity. They align employee incentives with enterprise value growth while maintaining cap table cleanliness and avoiding the need for corporate actions to issue, transfer or buy back shares. They also enable companies to tailor settlement timing to liquidity, which is particularly helpful for private companies that want to conserve cash during scale‑up. They also focus payouts around exit events.
Virtually unlimited design flexibility is another advantage. Vesting can be purely time‑based, purely performance‑based, or a hybrid of the two. Performance metrics can include revenue, EBITDA, product or regulatory milestones, and risk/compliance thresholds. Settlement can be configured to occur only on change of control, on IPO (with post‑listing valuation rules), or at periodic windows once vested. Plans can incorporate dividend equivalents to better mimic equity economics and can cap payouts to protect liquidity. Well‑defined good‑ and bad‑leaver rules, together with bad faith protections and clawback, sharpen risk alignment and address conduct, misstatement and control failures. For Singapore participants, the payment rules and limitations under the Employment Act 1968 do not apply in the same way they do for salaries.
Finally, administration and governance are typically lighter than for true equity plans, because awards are contractual rights to cash. This is particularly valuable in jurisdictions or group structures where issuing shares to overseas employees is burdensome or impractical. This is a crucial factor in jurisdictions where shareholder trust arrangements are not legally recognized.
Core design features and mechanics
Phantom plans ordinarily provide for board‑approved grants to specified categories of participants, with limits on the aggregate pool or per‑person awards. Vesting schedules usually mirror equity plans, such as four‑year vesting with a one‑year cliff and monthly or quarterly vest thereafter, optionally combined with performance gates. Settlement is cash‑settled by design, though some plans reserve discretion to defer payment or, if available and desired, to settle in equity equivalents.
Valuation methodology really ought to be specified. For private companies, this often involves an independent valuation at set intervals or on triggers, or a board‑determined fair market value under a stated approach (for example, discounted cash flow, comparable companies, or multiples), with adjustments for dilutive events, recapitalisations, or extraordinary dividends. Clear articulation of methodology reduces the risk of later disputes.
Leaver provisions are central to effectiveness. Good leavers (such as resignation after cliff, redundancy, ill health, death) typically receive prorated vesting or partial acceleration and settle at the next liquidity event or within a defined window. Bad leavers (for example, resignation before cliff or gross misconduct) ordinarily forfeit unvested units and, in some plans, vested‑but‑unpaid units. Malus allows reduction or cancellation of unvested or undeclared awards for stated triggers; clawback allows recovery of paid amounts if triggers emerge later. Plans should also define change‑in‑control and IPO treatment, including whether acceleration is single‑trigger or double‑trigger and how awards continue or convert post‑listing. Or in case nothing works, don’t forget a switching mechanism!
Accounting treatment of phantom schemes
From an accounting perspective, phantom plans are cash‑settled share‑based payments. This has several implications.
First, the awards give rise to a liability that is measured at fair value at each reporting date until settlement, with changes recognised through profit or loss. Expense is recognised over the vesting period, reflecting the service and any performance conditions. The need to remeasure the liability at each reporting date can introduce P&L volatility tied to changes in fair value and expected vesting, particularly in periods of valuation movement or when performance outcomes change.
Second, companies must ensure that their valuation methodology is sufficiently robust and documented to support the liability measurement, including adjustments for capital structure changes and major corporate events. Disclosure requirements apply, and group structures often necessitate intercompany recharge and transfer pricing support if participants sit in different employing entities within the group, so that expense and deductions accrue in the jurisdictions where services are performed.
Finally, liquidity planning is essential. Because phantom awards settle in cash, the company must fund payouts when they fall due. Plans frequently incorporate caps or staged payment mechanics to manage cash outflows, especially in exit‑only designs where all obligations may crystallise at once.
Tax and payroll considerations
Payouts under phantom schemes are typically treated as employment income when they become payable or are paid, depending on the plan terms and local rules. There is no “dry tax” issue! But this can attract payroll withholding and employer social charges in many jurisdictions. Employer tax deductions generally align with the timing of expense recognition or payment, subject to local deductibility rules.
Design and administration should anticipate cross‑border mobility, termination timing and payroll reporting. Where statutory social security applies, phantom payouts can fall within additional wage bases and annual ceilings, again subject to local law. For example, in Singapore, phantom payouts are treated as employment income and, for Singapore citizens and permanent residents, typically constitute Additional Wages for CPF purposes, subject to the annual wage ceiling. Expatriates are not subject to CPF, and tax clearance rules on departure should be managed through the plan’s settlement provisions. This means Singaporeans and Singapore permanent residents will technically earn more out of a phantom share option scheme than expatriates. These Singapore‑specific features underscore the importance of jurisdiction‑by‑jurisdiction analysis when extending the plan globally and trying to budget.
The overall tax‑payroll profile of phantom arrangements is thus straightforward but fully taxable. This can be less tax‑efficient for certain employee populations than some equity instruments, and employer social charges can add cost. That said, the employer typically receives a corresponding corporate tax deduction when the obligation is incurred or paid, which helps to offset the P&L impact.
Practical limitations and mitigants
Phantom plans are not without trade‑offs. The most salient is cash funding at settlement, which can be material at exit or at scheduled valuation dates. Thoughtful plan design—caps, deferrals, staged payments, and alignment of settlement triggers with liquidity—can reduce financial strain on the employer. Liability remeasurement introduces earnings volatility and requires ongoing valuation work. Because participants do not hold equity, some may perceive a weaker ownership connection; dividend equivalents and clear communication can help bridge this. Finally, if valuation is board‑determined without independent assessments, methodology disputes can arise; periodic independent valuations or enhanced disclosure can mitigate this risk.
When phantom schemes fit best
Phantom plans are particularly effective for private companies that want to align teams to value creation while preserving cap table simplicity, for groups operating across multiple jurisdictions where issuing equity is complex, and in scenarios where liquidity is expected at a defined event and can be used to fund payouts. They are also useful as a complement to existing equity plans, extending participation to non‑employee directors, consultants, or overseas teams working in associated companies where local securities or exchange controls complicate issuing shares.
The enduring benefits of traditional employee share option schemes
Traditional option schemes remain powerful in the right context. They create direct ownership and voting rights upon exercise, which can deepen alignment with long‑term value creation. They do not require cash outlay at settlement, which preserves corporate liquidity. In some jurisdictions, statutory option regimes provide favourable tax treatment compared to cash‑settled awards, enhancing employee after‑tax outcomes. Finally, equity‑settled awards generally avoid liability remeasurement and can reduce P&L volatility relative to cash‑settled arrangements. For companies that prize ownership culture, anticipate manageable cap table growth, and can administer securities law and shareholder matters, traditional option schemes can be the better fit—or an effective complement to a well‑designed phantom plan.
For more information on this article, please contact Jennifer Chih
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