Phantom Shares: How to align and retain key talent without giving up a single share

Why they work: From cost manager to co-investor

The retention of key talent is a pillar for preserving and increasing the value of an enterprise, particularly ahead of a merger or acquisition (M&A) process. Traditional variable pay schemes—annual bonuses tied to budgets or short-term accounting metrics—typically fail to align the manager with the shareholder's wealth vision, because management metrics do not always translate into a real increase in company value.

Phantom shares resolve that misalignment. They are a deferred compensation mechanism that synthetically replicates the behaviour of real shares or equity interests: they grant the employee a purely economic credit right linked to the company's value. They thus tackle the classic agency problem: the manager ceases to behave as a mere annual cost manager and begins to think as a co-investor in the project.

If the company is worth more, the manager's pay grows in the same proportion. And that alignment is especially valuable when preparing a liquidity event or exit, where the final transaction value determines the reward for founders and for the team that made it possible alike.

What exactly are they (and what are they not)

A phantom share is an economic right to receive a cash payment linked to the value or appreciation of the company, without becoming a shareholder. The beneficiary does not enter the share capital, does not vote, does not attend general meetings and has no information or withdrawal rights.

It is worth distinguishing phantom shares from related instruments:

Real shares/equity interests: the employee becomes a full shareholder; upon sale, the gain is largely taxed as a capital gain (savings tax rates).

Stock options: a right to purchase equity interests at a pre-set price; they require an outlay and turn the holder into a shareholder upon exercise.

Phantom shares: purely economic right settled in cash, with no outlay and no entry into the capital. It is the most widely used instrument in Spain for 'giving equity' to employees without actually giving it.

Two Main Designs

Full-value plan: the employee receives the full value of the units at the settlement date. Example: 500 units × €200 = €100,000.

Appreciation-only plan (SAR): the employee receives only the increase in value since the grant. Example: 500 × (€200 − €120) = €40,000. Equivalent to a Stock Appreciation Right.

Although cash settlement is the norm, the plan may provide for stock settlement: delivering real equity interests at maturity. This is a useful alternative to protect the treasury if the company lacks sufficient cash for a mass vesting event, although it then involves the corporate-law hurdles of delivering equity interests.

For everyone or only key employees?

This is the first strategic decision and it has a strong cultural component: there is no single answer. Distributing to the entire workforce is generous and reinforces belonging, but dilutes the individual incentive (each package is worth little) and multiplies the future cash cost. Moreover, a dual risk arises: that many employees undervalue the incentive (they sign and forget) or that they overestimate it unrealistically, doing sums with optimistic valuations without considering dilutions from future rounds, net debt or investor liquidation preferences.

Our professional recommendation leans toward concentrating phantom shares on key employees—those who can genuinely be explained and motivated by the instrument. If the decision is to distribute to everyone—a legitimate and generous choice—it must be accompanied by extensive financial education, so that each beneficiary understands the real magnitude, for better and for worse, of what they have signed. A poorly communicated plan becomes a source of frustration rather than motivation.

How to Retain Long Term: Vesting, Cliff and 'Golden Handcuffs'

The retention levers are: vesting (progressive consolidation, typically over 4 years), the cliff (initial waiting period, normally 1 year, before which nothing vests), the type of vesting (linear or staggered), and re-grants (refreshes on expiry to keep the incentive alive). Together they function as 'golden handcuffs': they make it economically costly to leave early. In a sale process, phantom shares act as an implicit stay bonus, because their payment is anchored to the liquidity event and sometimes to post-event continuity—exactly what reassures a buyer who fears talent flight after the transaction.

Phantom Shares vs. Stock Options vs. Long-Term Bonus

In limited liability companies—the vast majority of the Spanish business fabric—delivering real equity interests (stock options) encounters hurdles under the Companies Act: limits on treasury shares, general meetings, articles of association amendments, notarial execution and registry filing, plus the entry of minority shareholders that complicates governance. Phantom shares bypass all those obstacles, because they are a pure contract that does not touch the share capital. To set the initial value and the liquidity-event value correctly, it is advisable to rely on a professional business valuation.

How to implement them step by step

1. Modelling and metrics. Define the phantom share pool (indicatively between 5% and 15% of fully diluted value, lower in non-tech SMEs) and the grant-date base value, using standard methodologies: EBITDA multiples or discounted cash flow. Model the treasury impact.
2. Approval by governing bodies. It is advisable for the General Meeting to approve the broad parameters (pool, eligible beneficiaries, valuation criteria) and for the board to be authorised to execute individual contracts.
3. General plan rules. The framework document: vesting schedule, cliff, valuation method, liquidity event (trigger), economic rights, synthetic dividend if applicable, buyback and anti-dilution clauses, and the leaver regime.
4. Individual award agreements. With each beneficiary: units granted, initial value, vesting schedule and specific terms.
5. Accounting, monitoring and settlement. Recognise provisions at updated valuation and, when the liquidity event arrives, calculate the payment, withhold personal income tax and settle.

The most sensitive point is the valuation method: in a private company it must be contractually clear how the initial value and the liquidity-event value are calculated (multiples, last round or expert report). Ambiguous drafting here is the primary source of litigation.

Corporate and labour aspects in Spain

There is no specific corporate or labour regulation of phantom shares in Spain: they are atypical contracts governed by freedom of contract (art. 1255 of the Civil Code). As they are neither securities nor equity interests, they require neither notarial deed nor registry filing. That flexibility demands, in return, very careful drafting.

On the labour front there is an important case-law development: the Supreme Court judgment (Social Chamber) of 25 September 2024, confirming a 2023 judgment of the Basque Country High Court of Justice, classifies phantom shares as variable remuneration of a salary nature (they fall within the salary presumption of art. 26 of the Workers' Statute), as they derive from the employment relationship. The practical consequence: given their salary nature, it could be argued that amounts received should be taken into account in the regulatory salary for calculating dismissal compensation.

If a substantial payment from an exit is followed shortly by an unfair dismissal of a senior manager, the severance could increase significantly. It is therefore advisable to protect against these effects with express clauses in the award agreements, bearing in mind that labour rights are largely non-waivable.

Taxation of Phantom Shares in Spain

For the employee (Personal Income Tax)

Neither the grant nor the vesting generate taxable income: they are a mere expectation of payment.

The taxable event arises when the right becomes enforceable and the company pays (normally the liquidity event), pursuant to art. 14 of Law 35/2006. At that point, the amount is taxed as employment income within the general tax base of personal income tax (art. 17), with the corresponding withholding. This has been confirmed by the Directorate General of Taxes in recent binding rulings (V0784-24, V1128-24 and V1132-24).

The 30% Reduction for Irregular Income

To soften progressivity (the marginal rate can exceed 47% depending on the autonomous community), the 30% reduction under art. 18.2 may be applied, subject to strict requirements:

The generation period must exceed two years (from grant to payment). The income must be attributed to a single tax year (not split). The reduction must not have been applied to other irregular income in the preceding five years. The reduction base cannot exceed €300,000 per year.

Warning on plan design: the DGT has denied the reduction when the plan has annual vesting milestones or instalment payments, on the grounds that no generation period exceeding two years exists or that it constitutes recurrent remuneration. To secure the 30%, it is advisable to tie the payment to a single final vesting and settlement event (e.g. the exit), avoiding annual payments.

The key difference with the Startup Law

This is the most frequent misunderstanding and must be stated clearly: phantom shares do NOT benefit from the €50,000 exemption under the Startup Law (Law 28/2022). That exemption is reserved for the delivery of real shares or equity interests to employees of certified startups (employment income in kind). As phantom shares are a right to receive cash—monetary employment income, without delivery of securities—they fall outside: the employee integrates the full amount in the general base, without that exemption. It is the main economic difference versus stock options in a certified startup, and must be explained honestly to beneficiaries.

For the company (Corporate Income Tax and Accounting)

Under the Spanish Chart of Accounts (NRV 17), during the vesting period a personnel expense (account 6457) is recognised with a matching provision (account 147), which is revalued at each closing according to the company's updated value. Fiscally, however, the effective-payment rule applies: the provision recognised in interim periods is not deductible for corporate income tax purposes (requiring positive off-balance-sheet adjustments), and the expense is deducted entirely in the year of payment (negative reversal adjustment). This is confirmed by DGT rulings V3284-20 and V2118-22. For social security purposes, as employment remuneration, the amounts are generally subject to contributions up to the maximum base; this should be confirmed according to the plan design.

Advantages and Risks

Advantages

They do not dilute the capital or ownership; no new shareholders enter and governance is preserved. Maximum contractual flexibility (atypical instrument). They align interests and retain talent without any employee outlay. They work equally in SL and SA. They save fixed salary cost in early stages. Tax deferral for the employee: no tax until cash is received.

Risks and Disadvantages

They are taxed as employment income (high marginal rates), not as savings: less efficient than real shares, and without the Startup Law exemption. Cash cost for the company at the liquidity event: treasury planning is essential. Asymmetry in corporate income tax: accounting expense not deductible until payment. Risk of non-receipt for the employee if the exit does not materialise or the company does not grow: the incentive can be worth zero. Labour risk: their salary nature (Supreme Court 2024) may increase dismissal severance. Complexity of valuation and risk of litigation from deficient drafting.

What happens if the employee leaves: The Leaver Regime

A well-drafted plan defines what happens to the units depending on the reason for departure, through good leaver / bad leaver clauses:

Bad leaver: voluntary resignation without cause or fair disciplinary dismissal. Typically forfeits all phantom shares, both unvested and vested.

Good leaver: causes beyond the employee's control (objective or unfair dismissal, death, retirement, disability). Forfeits the unvested units but retains the vested ones.

For the vested units of a good leaver, the plan usually provides two routes: freezing (the employee waits for the exit to receive payment under the general rules) or early buyback (call option) by the company at current value, often with a 10%–20% illiquidity discount. The cliff acts as a filter: anyone leaving before the first year will normally have vested nothing.

Alternatives and when each is appropriate

Phantom shares are not always the best option. If the company is a certified startup and the goal is genuinely to bring in equity partners, stock options with the €50,000 exemption may be fiscally superior. If maximum alignment is sought and ceding control is acceptable, direct equity delivery may fit. If the sole objective is retention ahead of an imminent sale, a stay bonus or earn-out may be simpler. And for short-term incentives, the classic cash bonus for objectives. Phantom shares shine when the goal is to replicate the effect of equity without giving away equity: the typical case of the SME and the family business.

Conclusion

Phantom shares are a powerful tool for aligning and retaining key talent without touching the capital, but their effectiveness depends entirely on good design: to whom, how much, with what vesting, what valuation, what leaver regime and what tax and labour framework. Well structured, they turn managers into growth allies and into an asset that a buyer values; poorly designed, they generate frustration, litigation and treasury shocks.

At Maraz Corporate Finance we accompany the entire cycle: the business valuation to set the initial value and the liquidity-event value, coordination with the shareholders' agreement, preparation of the company for a sale or M&A process (where the plan becomes the retention piece) and management of the provision and treasury through our External CFO service. If you are thinking of implementing a phantom share plan, let's talk.

Javier de Rojas Roca de Togores

Partner – Maraz Corporate Finance

FAQs on Phantom Shares

How does a funding round or capital increase affect phantom shares already granted?

If no protection has been built in, the issuance of new equity interests dilutes the economic weight of the phantom shares. To neutralise this, the plan rules must include anti-dilution adjustment clauses that update the granted units, keeping their weight intact relative to the total valuation. This is a point that should be coordinated with the shareholders' agreement.

Are phantom shares taxed like real shares?

No, and it is a key difference. Phantom shares are taxed as employment income in the general personal income tax base (marginal rates), not as a capital gain (savings rates), and they do not qualify for the €50,000 Startup Law exemption, which is reserved for the delivery of real shares. That said, the 30% reduction for irregular income may apply if the plan is designed correctly (a single payment, generation period exceeding two years).

Can the incentive be collected without selling the company?

Yes, if so agreed. Payment may be linked to a synthetic dividend (when the general meeting distributes dividends, the beneficiary receives an equivalent bonus per unit) or to tenure milestones. But the most common approach is to anchor the bulk of the payment to the liquidity event of an M&A transaction (majority sale or change of control).

What happens to phantom shares if the company enters insolvency proceedings?

They are a simple credit right against the company, with no security interest and no shareholder status. In insolvency proceedings, the expectation of payment is classified as an ordinary or even subordinated claim, ranking behind preferential debts (public, priority employment claims, etc.). It is a real risk that the beneficiary should be aware of.

How is the value of phantom shares set in a private company?

This is the most sensitive point. The method must be defined contractually: market multiples (EV/EBITDA), discounted cash flow or independent expert report. A professional valuation of both the initial value and the liquidity-event value avoids the primary cause of litigation in these plans.