What is shadow stock and how does it work?

QUESTION:

I run a design firm, and I don’t want to go to all the trouble of giving out stock options to my employees and contractors.  I’ve heard people talking about “shadow” stock, where you promise to give people working for you a bonus equal to a percentage of the sale price of your company if it is acquired while they are still employed.  Is this what shadow stock is all about?  Can shadow stock be as simple as a bonus agreement tied to the milestone of selling the company within a given time period?

ANSWER:

Dan Walter

Dan Walter

by Dan Walter, CEO of Performensation

Shadow stock has two different definitions. Most commonly it is used in reference to a synthetic class of stock of publicly traded companies. The “shadow stock” strips out the impact of broad market movements and allows holders to see returns based more closely on true corporate performance. In truth, not a lot of companies do this.

The second definition is older and is more in line with what your are looking for. Francine is right in her response, as it relates to your question. Synthetic equity compensation awards are usually issued as Stock Appreciation Rights or Phantom Stock, although cash-settled restricted stock units and partnership units are often used for the same purpose.

In your case providing a “bonus equal to a percentage of the sale price of the company if it is acquired” would likely be designed as Phantom Stock or Cash-settled RSUs. Both of these instruments are what are called “full-value” awards. Meaning that there is no cost to the recipient, and when they are paid out, the individual receives a gain equal to the full value of the underlying stock.

These awards require consistent professional valuation of your company. They have some complex accounting issues (which some software systems can help with). They also require an understanding of the event horizon, including dilution issues that may impact the acquisition or sales price of your company and plan documentation.

My firm, Performensation, helps companies design programs like this and get them implemented and communicated. Feel free to contact me for more information.

I am also on the board of the NCEO (referenced by Francine). They are an excellent resource center for books on this topic: www.nceo.org

Equity Compensation Design and Use Matrix: stock options, restricted stock, ESPP, RSU, SAR, Phantom Stock and more http://bit.ly/dedCyu

Comments & Advice:
  1. Although “Shadow Stock” is sometimes used to refer to these arrangments it is more correctly titled Phantom Stock or Stock Appreciation Rights. These are a type of employee benefit that grants the right to receive an award based on the value of the company's stock. If the company is not publically held, then the plan needs to specify how the value is calculated. There are many ways to structure the plans. You would be well advised to consult a benefits expert/ labor lawyer to make sure the plan does what you intend it to do. As a starter visit http://www.nceo.org for a fuller description of the topic.

  2. Shadow stock has two different definitions. Most commonly it is used in reference to a synthetic class of stock of publicly traded companies. The “shadow stock” strips out the impact of broad market movements and allows holders to see returns based more closely on true corporate performance. In truth, not a lot of companies do this.

    The second definition is older and is more in line with what your are looking for. Francine is right in her response, as it relates to your question. Synthetic equity compensation awards are usually issued as Stock Appreciation Rights or Phantom Stock, although cash-settled restricted stock units and partnership units are often used for the same purpose.

    In your case providing a “bonus equal to a percentage of the sale price of the company if it is acquired” would like be designed as Phantom Stock or Cash-settled RSUs. Both of these instruments are what are called “full-value” awards. Meaning that there is no cost to the recipient and when they are paid out the individual receives gain equal to the full value of the underlying stock.

    These awards require consistent professional valuation of your company. They have some complex accounting issues (which some software systems can help with). They also require an understanding of the event horizon (including dilution issues that may impact acquisition or sales price) of your company and plan documentation.

    My firm, Performensation, helps companies design programs like this and get them implemented and communicated. Feel free to contact me for more information.

    I am also on the board of the NCEO (referenced by Francine). They are an excellent resource center for books on this topic. http://www.nceo.org.

    Equity Compensation Design and Use Matrix: stock options, restricted stock, ESPP, RSU, SAR, Phantom Stock and more http://bit.ly/dedCyu

  3. Kshitij Parikh says:

    How will such shadow option stock valued ?

Make Your Comment:


     Get Involved...