This article is a contribution by Attorney Hye-rin Kim of Choi & Lee Law Firm. If you would like to share quality content for startups in the form of a contribution, please contact the Venture Square editorial team at editor@venturesquare.net.
For startups and SMEs, securing and retaining competitive talent is key to sustainable growth. While many CEOs are likely utilizing stock options, granting shares can be challenging or inefficient in some cases. Phantom stocks are one alternative worth considering. While reviewing a company's phantom stock grant agreement, I felt it would be helpful to introduce the still-unfamiliar concept of phantom stocks to our readers as a means of sharing the fruits of the company's growth with employees. In this column, we'll explore what phantom stocks are, how they operate, and how they differ from stock options.
- What is Phantom Stock?
Phantom Stock (hereinafter "Phantom Stock") is a compensation method that provides employees with financial compensation linked to the fluctuations in stock value without granting them actual shares. While the term "virtual stock" is often used, these shares do not legally exist, and the employees granted the shares do not acquire shareholder status. However, if certain conditions are met, employees receive compensation linked to the stock value in cash or other forms.
In Korea, phantom stocks are generally understood as a form of compensation based on contracts, rather than a statutory system, unlike stock options, which are governed by the Commercial Act or the Venture Business Act. In other words, while phantom stocks may be classified as a type of stock compensation system, they are not legally considered "stocks" or "stock options." Since there are no specific legal provisions regarding phantom stocks, it is crucial to clearly define the terms and conditions of the contract.
- How Phantomstock operates and its types
The way Phantom Stocks are operated is mainly designed so that the company grants Phantom Stocks (Phantom Units) to employees by setting the quantity, grant price, and payment terms, and then, like stock options, sets a vesting period so that the rights can be exercised after a certain period of service or performance standards are met.
Phantom stocks are typically divided into two types: Appreciation Only and Full Value. Appreciation Only rewards the difference between the stock price at the time of exercise and the reference price at the time of grant, focusing on reflecting company growth. Full Value rewards the entire value based on the stock price at the time of exercise, making it a strong long-term reward in itself.
- Comparison of Stock Options and Phantom Stocks
Compared to the familiar stock options, the characteristics of phantom stocks are easier to understand. Stock options presuppose the grant of shares, and thus must meet requirements stipulated by the Commercial Act, the Venture Business Act, and other laws, such as a shareholders' meeting resolution and grant limits. Phantom stocks, however, are not subject to legal requirements, allowing for flexible and autonomous design in the form of a separate incentive contract. Furthermore, there are differences in the actual acquisition of shares and voting rights, as outlined below.
| item | stock options | Phantomstock |
| Whether or not actual stocks are granted | O | X |
| equity dilution | Possible occurrence | doesn't exist |
| Voting rights/dividend rights | Available after the event | doesn't exist |
| Cost processing | Costs are reflected step by step from the time of granting | Event timing |
As can be seen in the table above, the advantages of Phantom Stock include that it is not an actual stock grant, so the shareholding structure is not diluted from the perspective of the CEO or existing shareholders, voting rights are not transferred to the employees who are the grantees, so it does not affect the operation of the organization, and it allows for customized design such as vesting, performance linkage, and period designation.
- conclusion
In today's column, we introduced phantom stocks, a type of stock-based compensation system. Phantom stocks are a flexible compensation system that allows startups and SMEs to provide incentives to key talent while sharing in the fruits of corporate growth without diluting their equity. However, as a contract-based compensation system, implementation requires detailed design of contractual terms, vesting conditions, payment methods, and thorough review of relevant laws and regulations. Considering these factors, phantom stocks could be an alternative option for designing employee performance-based compensation systems.
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