Phantom Shares & Stock Options: Two Key Tools for Retaining and Attracting Talent for Startups

Human capital is the DNA of any organization and one of the driving forces behind its success. That is why recruitment and retention of talent tops the list of priorities for startups

For most early-stage startups, this is one of their biggest challenges, as their weak financial position generally prevents them from offering salaries or benefits comparable to those of large companies. However, there are ways to offset this disadvantage, creating a win-win situation and saving the company from having to pay salary costs in the short term.

We discussed this in our last talk CEO2CEO>Unfiltered Questions, organized in partnership with Netmentora Catalunya. During this session, we took an in-depth look at stock options and Phantom Shares—the two most commonly used variable compensation systems in startups to build employee loyalty and align their interests with those of the company. 

To this end, we draw on the expertise of Pablo Mancía, co-founder of Delvy and Quim Zurano Gallart, CEO of Paymefy. Keep reading this post to learn about these two tools, discover their pros and cons, and understand why they’re key to retaining and attracting talent for startups.

What Are Phantom Shares and Stock Options?

First, the stock options are a form of compensation, in addition to base salary, that grants employees the right to purchase shares in the company for a limited period of time (vesting period—usually 3 to 5 years—at an exercise price, that is, below market value. Essentially, they are offered the opportunity to become shareholders of the company under special conditions.

On the other hand, the compensation system for Phantom Shares provides an economic entitlement linked to the company’s shares or equity interests, typically amounting to 5%. The amount to be received is calculated based on the difference between the value of the shares or equity interests on the grant date and their value at the time of settlement. The mechanism is similar to that of stock options: to retain the right to receive payment, the employee must achieve the agreed-upon objectives and complete the vestingperiod, with this last point being the key to ensuring employee loyalty.

It is important to note that, since the employee does not have political rights, the employee will not be a member of the General Meeting of Shareholders. This is why Phantom Shares are also referred to as “phantom shares.”

As Pablo Mancía, companies can implement various Phantom Share plans as they grow. 

"Most often, the goal is to offer something tangible to people who have been involved in the project from the very beginning, the startup establishes a phantom stock plan during an early phase or when it is raising its first round of funding.”

Phantom Shares vs. Stock Options: Which Is the Best Option for Startups to Attract and Retain Talent?

As you can see, both are great tools for boosting the motivation and commitment of key project employees. However, although these are two incentive plans used to achieve the same goal, there are some reasons why Phantom Shares are the preferred option. We’ll detail them below:

• First of all, even though stock options are the most common option in the American startup model, their high personal income tax rate makes them difficult to implement in Spain. It is because of these tax issues—which create more disadvantages than benefits—that phantom shares have become the most widely used model in the country.
• On the other hand, in the case of stock options, one of their main disadvantages is that the entry of new partners also entails a change in the company’s equity structure, resulting in the dilution of existing shareholders’ shares. In contrast, as mentioned earlier, phantom shares do not alter the status of the company’s shareholders, so decision-making power remains with the original shareholders. This will prevent disputes and help attract future investors.
• The Phantom Shares system is also usually more convenient for employees, since it does not require them to make any financial outlay—a requirement of stock options—regardless of whether the value of the shares is below market value.

Although they offer more advantages than stock options, if you decide to opt for phantom shares, you should keep in mind that one of their main problems is often caused by the flexibility of their contracts. Therefore, to avoid future conflicts, it is essential to clearly establish how the shares will be valued when the time comes.

Case Study: Paymefy and Phantom Shares

As the CEO told us, Paymefy emerged from a pivot by the company QIDS. In fact, it was during the development of that previous project that the startup’s team identified an opportunity in the payments sector.

Switching from one project to another carries the risk of losing the partners you’ve already secured. That’s why they created a phantom stock plan designed to strengthen the founders’ influence and incentivize them to continue being part of this new venture.

Currently, Paymefy aims to establish a new plan to retain and reward talent, one that will foster the entire team's commitment to the startup's success.

"“I want to implement a plan that motivates every member of the Paymefy team to work alongside me to achieve the company’s goals, knowing that every time they do so, they’ll also be creating value for themselves.”” Quim Zurano, CEO of Paymefy

If you'd like to learn more about this topic, you can watch the full video of the CEO2CEO roundtable discussion featuring Delvy & Paymefy, held at Aticco , here.