Employee Stock Options and Phantom Stock Options

The main difference is that an employee receives real shares under an ESOP at some point. With a PSOP, the employee merely receives a contractual right to a payout in case of certain trigger events (typically the EXIT). This is why it’s called a PSOP – a phantom stock option plan. The employee does not receive actual shares but a contractual right built after shares; phantom shares.

Yes, when an employee receives shares (real shares), the difference between the price an employee pays for the shares and the tax value of the shares is treated as taxable income (with all consequences such as social security deductions). This is why we always recommend a tax ruling. Phantom (or virtual) shares, on the other hand, only have a tax implication if there is a liquidity event (i.e., the employee receives a cash-out).

Vesting means an employee has to earn their right to the participation instrument over time. The company wants to incentivize employees to stay with the company for as long as possible. Therefore, an employee must earn the right to receive shares (or phantom shares) by working for the company for a certain period. The market standard is four years with a one-year cliff.

In the first year of employment, the contracting parties typically determine whether it works out. Therefore, a cliff period of one year is market standard. If an employee receives options and leaves the company before the end of the cliff (i.e., the end of the first year), all options are forfeited. If the employee stays for at least one year, the first portion of the options vests.

Roughly: Payout = Phantom Proceeds – Exercise Price. The Phantom Proceeds are aligned with what the actual shareholders get per share, the Exercise Price is aligned with the price per share on the date the PSOP is implemented. Therefore, the employee participates linear in the additional value of the company.