Phantom Stock Plan - private company, 700 employees, $0.5B revenue, $10M NI.

Anon,

I might be a bit confused here. Phantom stock is typically for companies that have a clear market value. If you're private, it isn't so clear, with two broad exceptions:
1) You could consider creating dividend rights. Eg, CEO owns 1% (effective) of company, but all in Phantom Stock that is solely dividend-bearing. So, when a dividend is declared, she gets whatever the equivalent amount would be as deferred compensation (maybe classed as a bonus).
2) You create phantom equity that triggers in the case of an M&A event. Again CEO has no actual equity, but gets a bonus based on the price the company sells at. Interestingly, this is less toxic than stock options but can have the same structure. Say the company thinks it is worth between $1.5B (3x rev) and $150M (15x earnings). The owners want to sell, and would much rather see the former number, and wouldn't accept the latter. You set an effective option for a phantom share at, say, an effective company value of $300M. Below that the CEO gets nothing, above it she gets the increment over the phantom strike price. Since you're targeting an exit, this structure is less prone to the short-term focus that options drive.

Now, on to what I think your question might be: what's a good reward structure that mimics equity value? EVA. That's the only one that I know of that clearly tracks market cap. You get a bonus for liquidity, marketability and growth, but beyond that EVA is a pretty clean stand in. So, how do you structure this? Shooting from the hip, I'd suggest a deferred comp plan tagged to the 3 year trailing mean EVA, based on the starting point of the grant. Periodic grants, with a 3 year vest & 7 year expiration on each so they're not hanging out there forever. Depending on the structure, these are not unlike RSUs or ISOs. I would tend to strongly suggest structuring them like the former, so that there is a downside. Another way to structure this is something like a matching grant. They put in $50 for the Phantom RSU (EVA marked), company matches it, and then it vests over three years (and gains or loses value). Nothing drives retention like skin-in-the-game.

You might ask "why not 409a the stock, get a value, and track that?" 409a is great for safe-harbors, but in my experience doesn't act well at all as a proxy for enterprise value. The valuations are somewhat more consistent than they were in the days of yore, however bear in mind they are not just subject to mathematical whimsy (apologies to valuators out there), but also to the fortunes of the selected comps *and* the broader market as a whole. Let's say you have a banner year, EVA is through the roof, cash is flowing like water, and you're dominating your industry. Then the market falls in half. Are your owners worse off? No. So why punish the staff?

Cheers,

KP

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