Marta Gil de Biedma October 5 2022 What are phantom shares and how can they help start-ups to retain talent? López-Ibor Abogados | Corporate Finance/M&A - Spain Marta Gil de Biedma Corporate Finance/M&A IntroductionReal shares versus phantom sharesWhat are phantom shares?How are phantom shares awarded?Phantom share itemsTermination of phantom sharesCommentIntroductionThe start-up sector in Spain has now returned to pre-pandemic activity volumes. Although in the first few months of 2022, the volume of investment fell slightly compared with the same period of 2021, the number of transactions increased. In other words, the sector in Spain has carried out more transactions, albeit of a lower volume. This is interesting, because it means that investment has become more polarised, reaching smaller companies.Start-ups often have no history, proven success model or large financial resources. However, they usually offer an innovative, attractive and exciting business project with expectations of greater and faster economic success than traditional companies. Such ambitious plans require the best professionals in their sector. Attracting these professionals from more traditional, stable jobs with acquired rights requires, in addition to an exciting and challenging project, imaginative remuneration formulae that can compensate for a short-term loss in salary.Real shares versus phantom sharesThe best way to get the best professionals involved in a business project is to make them partners. However, this is not always possible or easy.Access to capital is usually by:purchase – they can buy shares or shares, which requires that there is someone interested in selling them and that the acquirer has money to pay for them. It is difficult for both of these to happen in a start-up environment; orsubscribing for the shares or assuming the shares in a capital increase, which also requires that the subscriber of the shares has the necessary funds.The vast majority of start-ups in Spain are incorporated under the legal form of limited liability companies, the creation and management of which is covered by more flexible and less onerous requirements and formalities than joint stock companies. However, under the Spanish Corporate Enterprises Law,(1) limited liability companies cannot have treasury stock to distribute to their employees, so systems of remuneration through stakes are difficult to implement. Further, there are times when, for practical or strategic reasons, it is not convenient for employees to be partners.Leaving aside other more complex formulae, retribution through "phantom shares" presents all the necessary ingredients to be an attractive alternative formula to real shares for start-ups in Spain. Owners of phantom shares will enjoy the same economic rights as owners of real shares. Moreover, they will not have to pay for them and there will be no dilution of real partners to allow for the entry of new partners.What are phantom shares?"Phantom shares" are an economic compensation that the company promises or delivers to the employee and that is linked to the value of the share. They are also known as "units", "points" or "restricted shares units" (RSUs). These terms all refer to the same thing: extraordinary economic remuneration linked to the value of the share.They differ from stock options in that at the time of accrual, stock options are converted into real shares, while phantom shares never give access to shareholders. This implies that the holder of phantom shares will not have to disburse any amount when the "vesting" occurs. Another important advantage over stock options is that no dilution of shareholders or partners occurs to give entry to new holders.Phantom shares are not specifically regulated in Spain. There are considered a kind of bonus and therefore the same regulation applies to them as applies to salaries, in terms of contribution base for social security and income tax. In addition, vested phantom shares in the previous year will be computed as salary for the calculation of severance payment in the event of dismissal.How are phantom shares awarded?Phantom shares are granted in a private contract between the company and the recipient of the shares. They can also be documented in a letter in which the company recognises these rights to the employee or in an annex to the employment contract. In short, they are documented in exactly the same way as any other bonus.Phantom share itemsIn the document by which the phantom shares are created – that is, the document that recognises the right of the holder to receive an economic remuneration (a bonus) – the conditions of the right will be established, including:how many phantom shares the employee is given – the company will establish a certain number of phantom shares (or points or RSUs) that will be granted to the employee based on certain parameters (eg, seniority, personal contribution or achievement of objectives);when the employee can collect their phantom shares – the so-called "monetisation event" will usually take place at the same time as a "liquidity event" for real partners: a dividend distribution, a transfer of shares or units or a transfer of assets. At the time that real shareholders receive money as a result of their status as shareholders, the holders of phantom shares will also receive money in proportion to the number of phantom shares that have been granted to them; andhow much the phantom shares are worth – the value of the "phantom shares" is calculated taking as a reference the value of the real shares. In other words, each phantom share or each multiple of phantom shares is equivalent to one share or participation or to a certain number of shares or participations, so that the value of the "phantom shares" is equal to that of the real shares or participations. Thus, employees will obtain the same dividend and the same "price" that they would receive if they had real shares in the event of transfer of the shares or participations or in the other agreed monetisation cases.It is also necessary to establish valuation formulae in the event of a merger or any other case of structural modification. Sometimes, phantom shares can also be valued by the difference in value between the time they are granted and the time they are collected.Termination of phantom sharesUnlike real holdings and shares, which do not expire (their transfer implies a change of ownership but not their extinction), phantom shares do – the cases in which this occurs must be foreseen. In general, they will go hand in hand with the future of the share. Thus, when the real shares are transferred, the phantom shares will be extinguished. However, like any bonus, it is common to establish that if the employee leaves the company before a certain period of time or is dismissed for just cause, the phantom shares are lost.CommentPhantom shares are a popular and particularly useful instrument for attracting talent to start-ups in Spain, especially those that are incorporated under the legal form of limited liability companies – in such cases, it can be very difficult to implement stock option plans or other share-based compensation models.The Spanish government has taken note of the dynamising potential of start-ups, and is processing regulatory changes to facilitate and promote entrepreneurship and encourage the competitive and stable growth of start-ups. The Start-up Law and the "Build and Grow" Law are projects that will come to fruition before the end of 2022 to dynamise the economy as part of the country's Economic Recovery Plan.In particular, the Start-up Law will place Spain at the forefront to attract investments, innovative entrepreneurship and talent. Among other measures, the Startup Law will make it possible for limited liability companies to acquire their own shares, up to a maximum of 20% of the capital, for delivery to the company's directors, employees or other collaborators, for the sole purpose of executing a remuneration plan.The Start-up Law also contains other important measures to attract international talent and recover domestic talent, encouraging the establishment of remote workers and digital nomads in Spain. It encourages the use of stock options as a payment method with a more favourable tax regime. However, phantom shares will continue to be the ideal mechanism for aligning employees with the company when, for various reasons, they should or cannot acquire shareholder status.For further information on this topic please contact Marta Gil De Biedma at López-Ibor Abogados by telephone (+34 915 21 78 18) or email ([email protected]). The López-Ibor Abogados website can be accessed at www.lopez-iborabogados.com.Endnotes(1) Royal Legislative Decree 1/2010, of 2 July 2010, approving the consolidated text of the Corporate Enterprises Act.