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Phantom Equity: How To Use It To Grow Your Business

By Business Contracts, Business Lawyer

phantom equity certificateIf you’re tight on working capital or don’t want to give up partial ownership of your company by granting shares or stock options, you may want to consider using phantom equity (PE) to compensate employees and independent contractors who are essential to the growth of your business.

What is Phantom Equity?

Phantom equity is a means to reward employees later (deferred compensation) when you can afford to do so. It’s common to tie such payments to key events for your company, such as meeting an annual revenues target for your products/services, sale of the business, a successful venture capital round, or your company goes public (IPO).

According to Texas Internet Lawyer Mike Young, whatever you choose as the payment triggering event must make sense as a “carrot” because you want to encourage workers to stay with you and perform in order to receive the compensation.

If structured correctly, you’re getting the same benefits from the workers with PE as if you had awarded sweat equity but without the headaches of dealing with minority shareholders in the process.

How Do You Pay Phantom Equity?

There are a variety of ways to pay out PE to your workers. Popular methods include:

  • A single lump sum payment triggered by one event
  • A series of bonuses paid as multiple milestones are achieved
  • Extra payment(s) into employee 401k retirement accounts

Who Should Receive Phantom Equity?

Because phantom equity is deferred compensation that reduces your share of the monetary pie, be careful who you choose to give it to. If an employee or independent contractor is essential to the success of your business, then that person is a potential candidate for PE, particularly if they’re willing to work for less now with the promise of deferred comp later if they perform.

However, if you can easily replace the worker with someone else, chances are phantom equity should not be included as part of that worker’s compensation package.

Setting Up a Phantom Equity Plan

Working with an experienced business lawyer and your accountant, you can form a phantom equity plan that’s right for growing your company with respect to, eligibility, vesting, and other legal and tax issues.

Sweat Equity: How to Trade Your Services for Business Ownership

By Internet Lawyer, Website Lawyer, Website Legal Documents

sweat equityIf you’re looking for multiple streams of income to support you, trading your services in exchange for sweat equity in Internet startups is one way to accomplish your goal.

From computer programming to search engine marketing, the possibilities are endless if you have a skill set that others want to use.

How do you trade your skills for business equity?

Typically, you’ll want to a hybrid package of compensation where you’re paid a portion in money and the balance for your services in equity consisting of corporate stock or LLC membership interests.

How much sweat equity should you receive when you barter your services?

That depends upon what you bring to the table and how much your client needs your services.

Which Internet startups are most receptive to giving you equity in exchange for services?

Small ecommerce businesses and startups that aren’t funded by venture capitalists or angel investors are your best bets for cutting a deal where you end up with partial ownership of the company by providing services.

However, it’s important to carefully evaluate these companies carefully because of high failure rates and the dishonesty of some entrepreneurs.

Should you trade your services solely for sweat equity?

It rarely makes sense to provide services only for equity. Most companies will not become the next Google or Amazon.

This means you’ll still want to generate some money on the front end to support yourself and consider the equity essentially a bonus if it pays off for you later.

Equally important, the client who insists that you trade your services solely for equity likely is broke and has a bad business model that will fail, leaving you with nothing to show for your hard work.

What about bartering services in exchange for payment over time by an Internet startup instead of equity?

In some limited circumstances it may make sense to accept partial payment now and becoming a long-term creditor of your client for the balance due for your services. This is different than the common practice of getting paid in installments based upon completion of certain milestones during a project.

As a practical matter, you’ll want to make sure you’re getting paid over the long term and there’s security in place to protect you in case the client defaults.

Whether you’re trading services for sweat equity or becoming a creditor by accepting payments over time, your Internet lawyer can draft the right legal documents to protect your interests so that you get the best deal possible. Remember, that if an agreement isn’t in writing, chances are you’re going to get screwed even if your client has the best of intentions.

To speak with Internet Lawyer Mike Young, the first thing to do is schedule a telephone consultation.