Phantom ownership: How to use phantom units to incentivize star employees

Businesses often face the challenge of attracting and retaining star employees. It can be tempting to offer star employees ownership in the business to prevent the hardship of losing star employees after investing time, money, and resources into training and onboarding. The main drawback of offering ownership is potentially relinquishing some control in the business. Employers that want to incentivize and retain star employees without relinquishing actual equity or control of the entity should consider offering star employees “phantom units” rather than membership interests of a limited liability company or stock in the corporation. This article will provide a brief overview of how phantom units and phantom unit agreements are used, what to consider when drafting phantom unit agreements, and how to align the interests of the star employee with the company through the use of phantom unit agreements.

What are phantom units?

Phantom units—commonly referred to as phantom stock or shadow stock—are a form of employee compensation or incentive mechanism, similar to the structures often used in employee stock ownership plans (ESOPs) or deferred compensation plans. Unlike ESOP plans, where employees typically receive actual ownership of company stock, phantom units are not actual shares. Rather, they are shares that equal the value of company shares.