phantom stock valuation formula

You give your salesperson units of phantom stock and each unit has a value of $10 based on the then value of the whole company. Using actual shares outstanding requires paying careful attention to internal share transactions. The foundation of the Black-Scholes method is an option valuation formula that incorporates the firm’s stock price, the dividend yield of the firm’s stock, the option’s exercise price, the expected term of the option, the interest rate on risk free securities and the expected volatility of the firm’s stock. Book value relies on stockholders’ equity set forth in the company’s financial statements to represent the value of the company. To learn why sharing value with those who drive growth is so critical to your pay strategy, download and read our report today! The value of the company can be established by a variety of means, including: Stock exchange (for public companies) It is widely applied in all areas of finance. Carefully consider how to address delivering value to the phantom shareholders when actual dividends are paid to the equity shareholders. This valuation determines the cost to purchase a share. Designed properly, phantom stock plans share the value growth of the business with the phantom stock plan participants in much the same manner as the equity shareholders share the growth. The plan valuation formula should be interpreted and the new share price determined and validated by company officers. Here's how phantom stock plans work: You give your executive 1,000 shares of so-called phantom stock at, say, $10 a share.The phantom stock … How Phantom Stock Plans Work. Generally accepted accounting principles (GAAP) are the standard for determining value. For stock option plans, the Black-Scholes approach is most commonly used. The number of shares to be allocated to employees simply becomes a fractional sub-set of the available hypothetical shares. For purposes of the following illustrations, assume there are 90 units, which represent 90 actual shares of stock outstanding, and 10 phantom units that are available for grant under the phantom plan. Purpose. Phantom Stock Plans can vary in their terms, but usually have two components: A share of annual net income (Profit Share); and, A stock appreciation right (“SAR”). deferred or incentive compensation which involves a promise to pay an amount to an employee at some future date –Phantom stock –Stock ... 9where the valuation is based on a buy-back formula ... (In other words, if a buy-sell formula applies to all transactions involving the company’s stock, then the buy-sell formula can be used to value stock as of a given date) 22. The approach used for valuation should take into account adjustments that the parties agree are appropriate. The phantom stock is not actual equity; however, it is tied to the value of the company's stock. 4. • Restricted stock units (“RSUs”) are phantom stock awards subject to vesting conditions. The value used for determining compensation to be paid may be determined by an arbitrary formula based upon the company’s performance or derived from a third-party valuation of employer stock. Customarily, they have observed transactions within their industry and are aware of key indicators and multiples. The formula above solves for value of actual equity and assumes the phantom plan is a liability of the company that reduces equity value. The calculation of book value generally requires the use of a “circular” equation to solve for the book value of the units, which is treated as a liability (expense) under GAAP. Pros and Cons of Phantom Stock. Thus, the payout will increase if the stock price rises, and decrease if the stock falls, but without the recipient actually receiving any stock. What does phantom-stock-plan mean? If the shareholders desire not to share dividends with phantom shareholders, the plan can be designed to share growth in enterprise value rather than equity value. A phantom stock plan, or 'shadow stock' is a form of compensation offered to upper management that confers the benefits of owning company stock without the actual ownership or transfer of any shares. Once these two answers are known, the phantom share price is calculated as the former (the value) divided by the latter (the number of shares). Earnings value formulas generally use earnings before interest, income taxes, depreciation and amortization (“EBITDA”) as a proxy for the operating cash flows of the business multiplied by a factor to determine enterprise value. This results in a “value dilution” potential of 9.1% (100,000 ÷ 1,100,000). Let's say under the terms of the agreement, the employee must stay with the firm for five years to benefit fully from the phantom stock deal. This is because not all shares are commonly issued at the same time. In this case, special adjustments must be made to offset the value of significant capital investments made by the company since there are no debt offsets. The units will represent a percentage of the total value of the company. This method eliminates the need to track adjustments to the company’s actual share count. This approach is used when there is no desire to keep the value of the real shares equal to the value of the phantom shares (although they will be close). The amount of compensation delivered to a phantom stock plan participant is based on the number of units he or she holds and the “phantom unit value” or “unit value.” In most plan designs, a maximum number of phantom units will be established in the plan. Some companies use their actual shares outstanding and “issue” new shares for the plan. Or it could promise to pay her an amount equal to the value of a fixed number of shares set at the ti… One of the key considerations is the valuation of the business. To receive more complimentary information about Phantom Stock from our expert advisors, please provide us with your contact information below. Examples of extrinsic factors that may impact the valuation include interest rates, competitor consolidations, and shortages of natural resources. This is a plus, as the value rendered should most certainly reflect a fair value; however, extrinsic factors are often not under the control of the executives in the plan and may reward or penalize the executives in the value of the phantom stock compensation. Decide how to award stock. The award is usually contingent upon the phantom This ensures the appreciation in value is resulting from earnings growth, not changes in the environment over which the executives have no control. Appraisers will often use a number of methods to determine value and may include both intrinsic and extrinsic factors in the determination of value. Book value does not necessarily reward for growth in value, however. The company should keep track of the dollar amounts owed and payable to employees and evaluate this amount relative to the increase in the company value since the date of plan inception. Once these two answers are known, the phantom share price is calculated as the former (the value) divided by the latter (the number of shares). Phantom Stock. What is the Valuation … The most theoretically sound stock valuation method, is called "income valuation" or the discounted cash flow (DCF) method. Nonetheless, utilizing actual share count can lead to confusion and an unfair result for shareholders or plan participants. This formula drives the company’s stock price higher as well. Unitizing the plan in this manner makes the math simpler. In some cases, it makes sense to limit the addition of cash balances to situations where the company has adequate working capital. For example, when buy/sell agreements use the same formula used for the phantom plan. Calculate EBITDA before the phantom stock plan expense. It generally makes sense to use a conservative multiple that does not change over time. Just like real stock, the shares are worth money and rise and fall with the value of the company. Although there are important tax differences—phantom stock plans pay compensation, which are taxable as wages, while equity shareholders enjoy dividends and capital gains—the value proposition can be very much the same. A phantom stock share is an unfunded bookkeeping unit, entitling the Employee to payment of the appreciation in value of the phantom stock share. Assuming an effective federal and state net tax rate of 35% for illustration purposes, the bonus payment yields net cash in pocket of $325,000, a reduction of $50,000 from the profit interest. Designing phantom stock plans can be tricky. If the value increases then an accounting is recorded as compensation expense together with the liability for future payment. Phantom stock plans have become very popular among private companies as a way to engage senior management, generally those who don’t have any actual equity ownership, in the value proposition of the business. For instance, a company could promise Mary, its new employee, that it would pay her a bonus every five years equal to the increase in the equity value of the firm times some percentage of total payroll at that point. The most common approach is to pay the phantom shareholders “dividend equivalent” bonuses or deferred bonuses. Thus, each phantom unit is equivalent to one percent of the value of the company. Based on that multiple, you could create 5,000,000 phantom shares at $10 per share, for a total valuation of $50,000,000. The Formula Value should ultimately arrive at a value that can be easily calculated from the company’s financial statements and fairly represents underlying economic value. TEXAS OIL & CHEMICAL CO. PHANTOM STOCK PLAN 1. If the valuation formula shows that the company’s stock has risen by $20 a share, the executive would receive a $40,000 check. That same $500,000 for the employees, paid out as a phantom stock compensatory bonus, would be taxed at ordinary rates. The value of phantom stock units is measured by the value of the company stock. Allows employees to share in the growth of the company’s value without being shareholders. Design of a phantom stock plan can replicate the value of real stock. For example, competitors may have sold to buyers for “6 times net income” or “5 times EBITDA” or “1 times revenue.” Such a formula may become the starting point for the discussion regarding the Formula Value. © Copyright 2021 Findley, A Division of USI, -40 (based on unit value resulting from calculation). This is a form of compensation where a company promises to pay cash at some future date, in an amount equal to the market or formula value of a number of shares of its stock. EBITDA formulas are common valuation formulas used to determine values for buying and selling company stock and can be effective in a phantom stock plan if a few design techniques are used: Once equity value for the company is determined, there are two possible approaches to calculate the actual unit value of the phantom stock units as illustrated below. ... Ready to Speak with a Phantom Stock Expert Now? This Phantom Stock Plan, (the "Plan"), of Texas Oil & Chemical Co. for a select group of management personnel is intended to advance the best interest of Texas Oil & Chemical Co. and subsidiary companies by providing such personnel who have a substantial responsibility for the management and growth of the … Appraisals can be expensive and using an outside appraisal may delay closing the books at the end of the year, since the current updated values are needed to adjust the company’s phantom stock liability each year. Perhaps you want to incentivize a salesperson for your company. Book value may or may not be representative of a true fair value for the company, but it is easy to measure and does a good job of sharing profitability with the phantom shareholders. A company may award annual shares for a number of years to a changing group of employees. If paid in cash, can be … Long story short: You can’t offer equity without knowing how much a share is worth. The objective is to determine the total enterprise value, which is then shared or allocated between the phantom shares and the real shares. Phantom stock is a contractual agreement between a corporation and recipients of phantom shares that bestow upon the grantee the right to a cash payment at a designated time or in association with a designated event in the future, which payment is to be in an amount tied to the market value of an equivalent number of shares of the corporation's stock. These entitle the holder only to a payment at a liquidity event equal to the increase in value of the LLC (based on a number of units) measured from date of the award to the date of the liquidity event. Phantom stock (also commonly referred to as “shadow stock”) represents an (b) In general, phantom stock is merely a promise by the company to pay a bonus in the future, usually based on increases in the equity value of the company.
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