According to the 2016 FOX Family Office Compensation and Benefits survey, only 30 % of offices offered long-term incentive plans.

Family offices are often looking for talent with specific expertise and understanding of a family office environment. Long-term incentives can be pivotal in attracting and retaining talented employees. Knowing such plans are not widely used, being innovative and creative in the incentives offered can be a key differentiator to attract and keep the most talented people.  

In FOX 2016 study, the long-term incentives used include deferred compensation, long-term performance awards, co-investment opportunities and phantom stock.
 

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-Monica Staco, Director of Research, Family Office Exchange

Attracting and Retaining Key Family Office Executives Using Phantom Stock Plans, by Bruce Benesh, National Partner in Charge, Human Capital Services at Grant Thornton

The use of equity-oriented incentive compensation is increasing in popularity as an integral part of a family office’s overall strategic compensation plan. In the recent 2016 FOX Family Office Compensation and Benefits Survey nearly one-third of all families offer a long-term incentive compensation plan. These plans tend to be reserved for management and executive level positions, and survey respondents indicated that CEOs, COOs and CIOs are the most likely recipients. For example, a properly designed phantom stock plan can be a key tool in attracting, retaining and motivating key executives. It also aligns the interests of the family members with the executive team.

An important goal of a family office is to provide executives with an incentive compensation plan that is based on achieving goals of the family members. This can be accomplished without actually giving equity to an executive, but instead by means of phantom stock or a simulated equity program. This is especially true where there is value that has been created in past years of service. Through the use of a Win-Win phantom stock plan all of the family and executive’s goals can be accomplished.  Also, since these are deferred compensation arrangements, and not qualified plans under the Internal Revenue Code (such as a 401(k) or qualified profit sharing plan), they can be customized to the goals of the family and executives, and only be offered to a select group of people.

Goals and Purposes of a Phantom Stock Plan

• Motivate key executives to “over and above” performance resulting in an increase in the value of the family’s assets
• Retain key executives in the family office (i.e., provide “golden handcuffs” ), which is very important as the family grows its wealth
• Attract key people to the family in the future and give them a stake in their office’s growth and profitability of the family assets
• Provide key people with an additional degree of long-term financial security
• Serve as an equity interest plan (similar to a stock or stock option plan) for key executives
• Create a “win-win” situation among the family office leaders and family members
• The plan is designed to recognize the financial contributions of a select group of executives by granting them a capital accumulation opportunity to share in growth of the family office assets without actual equity ownership 

How it Works

Basically, a phantom stock plan substitutes stock units for actual equity in either a corporate or pass-through entity (such as an LLC, S corporation or partnership). The value of these stock units are accumulated in a ''memorandum account" set aside specifically for the executive. The account is usually set up for a certain period of time (the ‘‘award period’’), which may extend until the executive’s leaving the family office, retirement or a certain number of years. This type of plan may also serve as a nonqualified supplemental retirement plan. The compensation paid to an executive from this plan is preferably linked to a valuation formula or any increase in the value of the family’s assets. In the 2016 FOX Survey mentioned above, the valuation methodology for family office plans was most commonly built around and related to investment performance such as rate of return (34%), increase in net asset value (20%) and performance benchmarks (12%). While the stock units are held in the phantom stock plan, the executive's account is usually credited with increases or decrease based on family asset values. At the end of the award or plan period, the executive usually receives the value of the units, which can be the initial value plus any appreciation  (or just the appreciation depending upon the plan design) on the units from the date they were actually issued.  In this manner, incentive compensation for participants under a phantom stock plan is directly related to the actual performance of the family assets and any increase in the value. The use of a consistent valuation methodology and the appropriate benchmarks in the plan avoids the need to have an actual appraisal of any asset values when a payment to the executive is due.

Considerations in Plan Design

Phantom stock plans can be relatively uncomplicated to establish and administer. They are certainly flexible enough to meet the goals of family office and family members. The value or amounts earned by the executive are “tracked” in a memorandum account. The plan should always be written and is usually represented by a contract between the company and the executive. The contract should address the following items:

• Number of units issued, including maximum number of units that can be issued under the plan
• Frequency of issue dates (i.e., either periodically or on a one-time basis)
• Provisions for the issuance of additional units
• Method for valuing the units during and at the end of the award period
• Employee's access to payments in the event of death, retirement, resignation, discharge, disability hardship; and the availability of an election to defer or accelerate payments and change of control
• Method of payment (normally always in cash)
• Time of payment (e.g., lump-sum or in installments)
• Vesting schedules.
  • Length of the award or plan period

The above are matters that are addressed in the design process. Since the plan is a contract between the family office and the executive, phantom stock plans are the most flexible long term incentive vehicle. These plans are often part of the entire employment contract between the company and the executive since they are used to attract and retain the most qualified personnel.

Tax consequences of phantom stock

Generally, the compensation provided under a phantom stock plan, whether paid in cash or other assets, is ordinary income (subject to withholding) to the executive, with a corresponding tax deduction to the family office when the cash changes hands.  Since the object of a phantom stock plan is to provide equity-based compensation without issuing actual shares, the compensation is almost always paid in cash. Thus, the primary issue in dealing with the tax consequences of such a plan is the timing of the receipt of cash and payment of the tax by the executive.

Summary

An equity-based incentive compensation plan can play an important role in helping families achieve their business and compensation goals. They serve as an effective means of attracting, motivating, and retaining top executive talent that is so critical in today’s environment. Phantom stock is the most customizable and flexible vehicle possible to align the goals of the family members with those of their key executives.