Phantom Stock (Shadow Equity)
Definition
Phantom stock, also called shadow equity or shadow stock, is a contractual bonus that pays an employee the cash value of a set number of notional shares without granting real equity or ownership. The payout tracks the company’s share price or a valuation formula, so recipients share in the upside but never appear on the cap table.
How it comes up in fundraising
Startups reach for phantom stock (and the related SARs, or stock appreciation rights) when they want to reward key people like equity but keep the cap table clean, avoid adding shareholders, or grant to contractors and non-US staff where options are awkward.
Frequently asked questions
Is shadow equity the same as phantom stock?
Yes. Shadow equity, shadow stock and phantom stock are three names for the same arrangement: a cash bonus that tracks the value of a set number of notional shares. Stock appreciation rights (SARs) are a close cousin that pay only the rise in value, not the full share value.
How is phantom stock different from stock options?
Options give the right to buy actual shares at a strike price; phantom stock never transfers ownership. It is a deferred cash bonus tied to share value, so there is no exercise, no strike price, and no dilution of real equity.
When does phantom stock pay out?
Usually on a trigger like an acquisition, IPO, or a set date, and often after a vesting schedule. Until then it is an unfunded promise, and the payout is generally taxed as ordinary income rather than capital gains.
What are the trade-offs of phantom stock?
Recipients get no voting rights, no QSBS treatment, and ordinary-income tax instead of the lower capital-gains rate, while the company carries a cash liability at exit instead of settling in stock.
Round Funded resources
Cite this term
Round Funded. "Phantom Stock (Shadow Equity)." Startup Fundraising Glossary.
Stable URL, it will not change: https://www.roundfunded.com/en/glossary/phantom-stock
Related terms
Terms that come up alongside Phantom Stock (Shadow Equity) in a fundraise.
- Option PoolAn option pool is equity reserved for employee compensation, typically 10 to 20 percent of the company, refreshed at financing rounds.
- VestingVesting is earning equity over time or milestones; unvested shares are forfeited on departure.
- CliffA cliff is the initial period of a vesting schedule during which no equity vests; if the person leaves before the cliff, they keep nothing.
- EquityEquity is ownership in a company, represented by shares.
- DilutionDilution is the reduction of existing shareholders’ ownership percentage when new shares are issued, whether in financings, option grants, or SAFE conversions.
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