November 2017 eNewsletter

Why Phantom Stock Can Help You Retain And Recruit Key Employees

Doug Meyer, Managing Director, Brixey & Meyer

How do I generate ownership mentality while not giving up equity in my company?

It’s common to get this question from clients.  In today’s war for human capital, we continue to hear challenges relating to recruiting new talent and retaining key team members. There are certain situations where the long term strategic plans to transfer equity to key team members definitely make sense. When that is not the case, implementing a phantom stock plan may meet both the owners and key employees’ goals.

A phantom stock plan is a contractual agreement wherein a company promises to make cash payments to employees upon the achievement of certain conditions.  The purpose is to generate an ownership mentality and reward key employees for helping grow the business value. It also allows the company to give the employee the economic benefit of being a stockholder without giving her the rights of a shareholder under state law.

An account is kept to track the number of shares/units per employee participating in the plan. Shares are not actually purchased or issued, therefore the account is mainly for bookkeeping.  At the end of a deferral period, the employee is paid an amount equal to the market value at the time the shares are credited to their account (see example below). 


Company does not want to provide real stock ownership to its key employees, but does want to provide an additional incentive through its compensation package to attract and retain valued employees. 

The company decides to set up a phantom stock plan. Phantom stock plan units are valued at the market value of the company’s stock shares and a key employee is awarded 1,000 units when the fair market value of a real share of the company’s stock is $50.  The phantom plan expires at the end of 10 years (example term) and the value per share is now $70.  Since the price of the phantom shares tracks the price of the real shares, the employee would be entitled to a cash payment equal to the increase in value of 1,000 shares or $20,000. This creates a tight alignment with the shareholders without the pain and complication of dealing with a stock transaction.

Employers and employees can benefit from using phantom stock strategy in a number of ways. 

Benefits to Employee:

  • Provides incentive to the employee.  Gives them a sense of personal interest in the company to assist in increasing productivity for the organization.
  • Provides motivation to the participating employees to work harder and take “ownership” in the company.
  • No cash outlay is necessary by the employee to obtain shares/units.
  • Great way to attract and/or retain key talent.
  • Does not recognize income when the shares are issued, only when converted.

Benefits to Employer:

  • Avoids diluting the interest from the owners of the company.
  • Current profits can be utilized to grow the company since this type of incentive plan is deferred until later years.
  • The plan does not afford participants in the plan common shareholder rights such as voting on shareholder matters.
  • The plan is Nonqualified, therefore its participation requirements are not the same when selecting which employees participate as under ERISA and qualified plans. 
  • Flexibility to link an employee’s performance to rewards.
  • The company receives a deduction in the year the payment is actually made.

Potential Negatives of Phantom Plans:

  • Employees do not receive actual ownership in the company.
  • Payments are considered taxable wages to the employee.
  • Benefits reduce the company’s net earnings (as a deduction is allowed when benefits are paid).
  • The company may have to pay for a valuation to be done to determine fair market value of the shares.

Potential Questions:

  1. When are phantom shares given and when is payment made?
    The company decides when the phantom shares are issued, how many will be issued, how often they will be re-valued, and when they will be redeemed.  Payment is typically at end of phantom plan period.
  2. Where does the company get the cash to make the payments?
    Without proper planning the cash position of the company could be severely impacted when the time comes to meet the phantom stock obligations.  A cash reserve and budget could be established. Depending on the situation and terms of the plan, hedging could be done to cover the obligations. For example, if some of the benefit is paid upon death, a life insurance policy could be taken out on the employee.How is the stock taxed?
  3. The employee does not recognize income upon issuance of the shares. The employee recognizes ordinary income and the employer will receive a deduction at the time the phantom shares are converted.
  4. Can the company pay a dividend?
    Dividends may be paid to the holders of phantom stock units or credited to their accounts and paid at a later date.  This tends to align the financial benefit of the holders of phantom stock shares with those of real share owners.  The company can turn around and take a deduction for these dividends.
  5. What is the company’s obligation to participating employees?
    Once vested, the company owes the employee the money, even if there is a hostile relationship between the company and employee.
  6. What if the value of the stock decreases?
    The employee in this case will not incur any liability (also a benefit). However, they also won’t receive any intended benefit of the plan.  The company may consider implementing a provision that would counter the decrease, especially if the employee has performed well during the period.

Your phantom stock plan is a symbol of your commitment to a partnership relationship. Key employees want to know that they have a chance to participate in the value they help create. A phantom stock plan, properly designed, can enhance a company’s efforts to attract, retain, and motivate key employees by aligning their interests with those of the company.

The Bug List: A Checklist of System-crashing Flaws in Software Development and License Contracts

Stephone E. Gillen, Wood Herron & Evans LLP

You've already done a lot of work: creating your requirements definition, identifying and qualifying prospective vendors, evaluating their proposals, selecting a winner and doing your due diligence, negotiating refinements to their proposal. But before you sign the vendor's form agreement, be sure and measure it against this list of common shortcomings that can, if not corrected, leave your expectations unfulfilled.

What are you really getting?

Contemporary software applications are complex, and ever evolving. You want to be sure that the license accurately specifies: which applications you are getting; whether it will run in your existing environment and if not, who pays for required improvements; whether you are getting the software in executable form only or whether you are also getting source code; and what sort of documentation will be provided.

It's undoubtedly correct to say that if you don't get this right, nothing else will matter. But as a practical matter, it is unlikely that you as a business person will be able to provide the details. Much of this will take the form of schedules and exhibits to the agreement (requirements document, RFP and response, published documentation, proposal, etc.). Your task is to ask the right questions of the right people to be certain that both you and the vendor have a common understanding and that the details have been adequately memorialized in the agreement.

And as complex as all of this sounds, understanding the scope of your ownership rights or licenses can be even more bewildering.

Using your software in ways not permitted by your license will almost certainly constitute a material breach of your license agreement (probably voiding your warranties and in some cases triggering an automatic termination of your license). Moreover, such activity may well constitute an infringement of the vendor's copyrights in the software.

What will it really do?

If you've made your purchase decision based on the performance representations made in the vendor's sales literature or made by the vendor's sales agents, you may be in for a disappointment. Make sure that you understand exactly what the license agreement says about what the software will do and that, if the license references user documentation in this regard, that you look to see what that documentation says about functions, features, and performance (including meaningful, measurable response time parameters) and do not simply rely on what you have been told. If you have spent the time and effort to work up an RFP and negotiate a proposal in response, be sure that the contract includes an affirmative obligation on the part of the vendor to deliver a system that complies with that documentation.

What will it really cost?

Is the license offered for a one-time fee or must it be periodically renewed? In either case, the license fee may be only a part of the cost of acquiring a new application. Will some customization be required? Will existing databases have to be converted? Are there separate support and maintenance costs? Are increases subject to some sort of limit or notice requirement? Don't overlook these additional costs as they may outstrip the initial license fees.

What happens if you have a problem?

Try as you might to diligently check out the vendor and the product, and as careful as you might be in reviewing the license agreement, contemporary software applications are complex and error free operation should never be assumed. Assume that, having completed your implementation and having switched over to your new system, you will experience an error, failure, or disruption at the most inopportune moment -- satisfy yourself that, under those circumstances, the remedies laid out in the agreement would be sufficient to allow you to sleep at night and that's just what you will be able to do.

  • Is there a monetary remedy in the event the vendor can't make it work?
  • Do you have to surrender the system in order to get access to the monetary remedy? Are you allowed to retain the system for long enough to make an orderly transition to a substitute?
  • Does the contract include a limitation on the vendor's liability -- to a refund of license fees only (common)? Or do you get back all sums paid? What about reimbursement for data and file conversion costs?
  • Is a copy of the source code in escrow? Will it be current? Will it be useable by you?
  • If failure would be catastrophic, do you need to consider insuring against this risk?

How One Ohio Company's Culture Transformation Drove Revenue and Profits Skyward

Lynne Ruhl, Perfect 10 Corporate Cultures

A toxic corporate culture had Bullen Ultrasonics in dire straits a few years ago. The company’s president, Tim Beatty, knew it had to change if the Eaton, Ohio-based manufacturer of custom ceramic machining was to survive.

Tim and his team reached out to the Goering Center at the University of Cincinnati. That’s when I first met Tim and became aware of Bullen Ultrasonics.

Unfortunately more setbacks were to come for Bullen. Ten months later, in August 2014, Tim called to tell me that some important customer relationships were at risk, and three of Bullen’s top thought leaders had left the company. There was no doubt the business would end up in the red that year, and the environment at the family-oriented firm was having adverse effects on marriages and other family relationships.

It took a lot of effort to change the culture at Bullen, but over time, it has become one of the more respected companies in the region.

Tim and his team worked with Perfect 10 Corporate Cultures to instill the principles of a positive and productive corporate culture − the same principles at the heart of the Goering Center’s newest educational program for family and private businesses. The Communication & Culture Institute will launch this February, helping business leaders inspire meaningful change across their organizations.

At the Institute, we will show business owners how solid communication is the foundation of a positive work culture. Together with their senior leaders, as well as family members who work in or have ownership interest in the business, teams will discover how to engage and empower their employees. The outcome is a workplace environment that is effective and productive, putting businesses on a path of profitable growth.

In our six sessions we’ll focus on the following topics: listening; inspiring respect and trust; self-control, management and deception; effective confrontation; and conflict resolution. Teams will take time to practice and refine their newly acquired skills and will develop agreements and action plans to ensure good communication and the resulting positive cultural impact.

Bullen’s Resulting Growth

This information helped Tim and the Bullen team to implement elements of a healthy culture.

Now, Bullen managers and employees work with each other to develop the narratives that drive the company forward.  For those narratives to be authentic and accurate, listening to one another and respecting and trusting the input of others are key. Ultimately, this creates a harmonious atmosphere where expectations are clearly communicated.

Today, the Bullen team practices self-control, effective confrontation and conflict resolution – skills gained and practiced through our work together – to inspire each other and over time, change behaviors across the organization.

While cultural transformation was inspired by Beatty and his leadership team, the action plan involved educating and empowering employees. Machinists, for example, for the first time learned how their work impacts gross margin. They started asking questions like, “I think on my machine, if I do this instead of this, I can save 15 seconds. Does that help gross margin?”

These cultural changes are still underway, but the impact is already measurable:

  • Two of the three key leaders who left returned to the company.
  • Revenues have soared 75 percent.
  • Revenues per employee are up 40 percent.
  • Profits have increased 190 percent.
  • Profit per employee is up 56 percent.

Bullen’s story is not unique. Of all the factors that impact a business, culture has the strongest statistical correlation to bottom-line results.

When a 2009 study by the University of Minnesota, University of Southern California, London Business School and Cambridge University measured 32 factors arrived at that conclusion, it shocked the corporate world. Most had no idea that culture had that kind of direct impact on profit. 

But even when a business owner recognizes the need for a cultural change, it’s difficult to pull off. That’s because 1) it’s difficult, without outside guidance, to change a culture you are part of, and 2) it requires a new set of skills.

These skills are not taught in high school or even college – in fact, most MBA students don’t receive this education. Goering Center’s Communication & Culture Institute was created for business owners who have the desire to learn the skills necessary to build and lead a healthy culture at their business and become more successful.

Four Ways to Ensure a Succession Plan Works and The Eight Proven Steps to Success

The Goering Center Team

It’s estimated that 80 to 90 percent of all business enterprises in North America are family firms. As a group, family firms are our biggest employers, and make up the greatest part of America’s wealth. But they are complex and tricky enterprises, especially when it comes to generational transitions of ownership. About 30 percent successfully pass to the second generation, while only 10 to 15 percent last into the third.

In order to implement a successful ownership and leadership succession plan, businesses must address four key factors. Before we can understand how those factors help, we need insight into the unique challenges that family businesses face.

Unique Challenges

Contemplating transition brings up hard questions, and big decisions, that affect everyone involved. How and to whom do I transfer owner­ship and leadership? When and at what price? How can I let go? How much income will I need? What will I do, who will I be, and what will my life be like after the transition?

Potential successors face related issues. They often ask themselves: Am I ready? Can I do it on my own? Would I be happier doing something else? What is the business worth? How will I finance the purchase? Will I be accepted? Who can help me figure it all out?

There are four key factors that contribute to successful transitions of ownership.

  1. First, the owner/founder and potential successor must know their strengths, weaknesses, personal characteristics and develop­ment needs.
  2. They also must recognize the issues that will affect whether ownership transition is successful, or not.
  3. Both generations take time to understand the proven, time-tested processes available to deal with common issues.
  4. They consult knowledgeable, expert peers, mentors or advisors who understand their specific situation and provide ground­ing advice and support throughout the process.

Eight Steps to Success

Founders/owners and their “next generation” successors must identify succession planning issues and address them together in order for a successful transition of control and ownership to occur. If both generations invest the time to follow these eight steps, and if they do the eight steps in order, they will increase their chances for success. Be advised it’s not a quick fix and can take from two to ten years or more depending on circumstances.

  1. Build a proper foundation for succession to occur. Assess each generation’s readiness, and learn and practice proper communication techniques that instill respect and trust between all constituents. Employ tools like codes of conduct, family meetings and family charters to clarify understanding.
  2. Form a network of advisors, including attorneys, accountants and bankers, boards of advisors, and peer groups consisting of individuals from other family firms.
  3. Clarify your goals, communicate your expectations and develop contingency plans to address the operational and succession issues that could derail your efforts.
  4. Develop and implement a strategic plan. Understand your known unknowns, your unknown unknowns, and what’s changing in your industry.
  5. Work with your team of advisors to gain an informed perspective on valuation methods and financial structures. Be sure the method and structure that you choose is the best choice for your circumstances.
  6. Optimize your legal and tax structures by clearly understanding the goals and hurdles of the transition, the forms of transactions available to you, and the implications of taxes and timing.
  7. Communicate your plan to all of your constituents – family members inside and outside the business, team members, key customers and strategic partners – including your banker.
  8. Finally, develop a plan of action. Someone must take ownership and drive the process for a succession plan to be successful.

Apprehensive? You’re Not Alone

Studies show that many business owners fail to plan their succession. When lead­ers serve as the head for both business and family, they may believe that their succession wishes will be carried out posthumously – simply assuming their family will know what they want to hap­pen after their death and execute their plans accordingly.

What leaders often do not anticipate is the strife that occurs when a succession plan is not clearly in place. Commonly, the family or management team does not agree with the wishes of the leader that has passed away, resulting in dissen­sion and chaos.