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Phantom Stock: what are your issues and experiences?

This Q is driven by both some recent run-ins with Phantom Stock in its newer form, and by an Anon question here: https://www.proformative.com/questions/phantom-stock-plan-private-company-700-employees-05b-revenue-10m-ni

My basic question, in 3 parts: Assume a private company, later-stage (revenue, heading toward profitability) puts in a Phantom Stock plan that is triggered only by a change of control (M&A, IPO...that sort of thing). It pays the holder of a Phantom Stock "unit" the equivalent of what a preferred holder would get in cash, not counting what the preferred holder paid in. So, let's say a holder of a Preferred Share gets (net of costs) $10 for that share in an M&A event. The holder of a Unit would also be due $10. Two features of this are that it is a vesting thing, so that you need to be vested in order to get paid. It is also *not* like restricted stock, wherein if you leave prior to the change of control, you forfeit all rights and don't get anything. This is in essence a "bonus" payable upon successfully driving the company to an M&A, and never ever has any equity rights, nor is it debt. Q1) This smells like straight comp. Does anyone have experience in handling this in an 83B-election or similar structure where it becomes a capital gain and not income? Q2) The forfeit-on-departure; that's a red flag for me. Is that common? I've *seen* it commonly, but it seems to be a bit lopsided, given that there is also vesting. Q3) Do you account for this thing? How? There is some guidance out there referring to ASC 718-10-35-8, however, the forfeiture issue weighs heavily on my mind; additionally the valuation seems...troublesome? Do a 409a on grant, and you're probably undercalling it. Thanks! Keith

Answers

David Howell, ASA, MBA
Title: Principal, Plante & Moran, PLLC
Company: Plante Moran, PLLC
(Principal, Plante & Moran, PLLC, Plante Moran, PLLC) |

Not knowing all the facts and circumstances, here are some thoughts: (1) This is probably deferred comp and may be subject to 409A, whether it is cash or share based. Since it is based on the value of preferred, that sounds like share based (equity). Need more info to comment on the 83B. (2) Some companies may not want employees (terminated or otherwise) that have left the company to continue to have an equity interests into the future. Not unusual. Forfeiture or redemption are some choices that are common. (3) Under ASC 718 this is probably a share based payment, with income statement and potentially balance sheet treatment, and the AICPA practice guide gives guidance on how to approach valuation. Let me know if you need any help figuring that or the accounting out.

David

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