Equity, Stock Options and Phantom Shares: a CEO's guide
With the holiday season approaching, many CEOs and directors take the opportunity to "gift" their teams something more valuable than a traditional present: participation in the company's success. However, terms like equity, stock options and phantom shares are frequently used without everyone being clear about what they really mean.
Knowing the terminology is good, but understanding what we are talking about is essential. In this article, we explain these three forms of capital participation and their practical differences, so you can make informed decisions whether you are a founder or part of the team.
Equity: Being a Real Partner
Equity is the most direct form of participation in a company's capital. It is the closest thing to receiving a real slice of the pie: not a bite, but a tangible part of the business.
When you receive equity, you enter the company's share capital directly. This means that:
- You have real rights as a shareholder (voting rights, information rights, the right to share in profits)
- You take on responsibilities as part of the project (you may bear responsibility in strategic decisions)
- You are officially part of the corporate structure (you appear in the Commercial Registry)
- You participate in strategic decisions according to your percentage (shareholders' meeting, sale decisions, etc.)
- You are entitled to a proportional share of the company's value in case of sale or liquidation
How Equity Works in Practice
Practical Example
Imagine a startup valued at €1 million and you are given 5% equity. This means that:
- ✓ You own 5% of the company from day one
- ✓ If the company is sold for €10 million, your share is worth €500,000
- ✓ You have voting rights on important decisions according to your percentage
- ✓ If dividends are paid, you receive 5% of them
What is Vesting?
Equity usually comes with vesting, a mechanism that lets you acquire your stake progressively. For example, 4-year vesting with a 1-year "cliff" means that:
You receive nothing
You acquire 25% (1 year out of 4)
You acquire 1/48 of the total
You hold 100% of your equity
Tax Considerations for Equity
In Spain, receiving equity has important tax implications:
If you receive equity as consideration for work, it is treated as employment income and is taxed under Personal Income Tax (IRPF). The value is calculated based on the market value of the shares.
If you sell your shares, the difference between the sale price and the acquisition value is a capital gain taxed under IRPF (19-23% depending on the amount).
If the company is sold, you receive your proportional share and are taxed as a capital gain.
When it is used
It is typically granted to key profiles such as co-founders, first strategic hires, and people who "decide the future of the company".
Typical ranges:
Co-founders: 20-50%
First employees: 0.5-2%
Important
Equity gets diluted in future investment rounds. If you hold 5% and an investor comes in buying 20% of the company, your percentage decreases (although the total value of the company may have increased). This is normal and expected in startup growth.
Stock Options: Being a Partner... If You Exercise One Day
Stock options are different. Here you are not given the shares directly, but rather a right (option) to buy shares in the future at a price set today.
It is like having a voucher to buy something valuable in the future at today's price. If the company grows and its value increases, that voucher can be worth a lot. If the company does not grow as expected, it remains a "we'll see".
How Stock Options Work
Stock options work in two phases:
- Phase 1 - Grant: The company grants you the right to buy a specific number of shares at a fixed price (strike price or exercise price). This price is usually the fair market value at the time of the grant.
- Phase 2 - Exercise: When you decide to exercise your options, you pay the strike price and receive the shares. From that moment on, you are a real shareholder of the company.
Practical Example
Initial situation
10,000 stock options × €1 strike price = €10,000
After 3 years
Value per share: €10
Potential gain
€90,000
(€100,000 - €10,000, before taxes)
Vesting in Stock Options
Stock options almost always come with vesting. The most common vesting is:
- 4-year vesting with a 1-year cliff
- This means that if you leave before 1 year, you lose all the options
- At the 1-year mark, you acquire 25% (you can exercise 2,500 of the 10,000 options)
- Each additional month, you acquire 1/48 of the remaining total
- At 4 years, you can exercise all options
Tax Considerations for Stock Options
In Spain, stock options have a special tax treatment, particularly for ENISA-certified emerging companies:
- Upon grant: There is no taxation at the moment of grant (unlike direct equity).
- Upon exercise: The difference between the market value and the strike price is treated as employment income and taxed under IRPF. However, for certified emerging companies, there is an exemption of up to €50,000 per year.
- Upon selling the shares: The capital gain (difference between sale price and acquisition value) is taxed as a capital gain (19-23%).
- Tax deferral: In emerging companies, you can defer taxation for up to 10 years or until a specific event occurs (sale, IPO, etc.).
Tax Advantage (Emerging Companies)
If you work for an ENISA-certified emerging company, you can benefit from the €50,000 annual exemption when exercising your stock options.
Example:
Value at exercise: €60,000 - Strike price: €10,000 - Exemption: €50,000
You are only taxed on €0
When to Exercise Stock Options
Deciding when to exercise your stock options is crucial. Factors to consider:
- Liquidity: You need cash to pay the strike price. If you do not have liquidity, exercising can be difficult.
- Current vs. future value: If the company is growing fast, it may be worth waiting. But if there is a risk the value will fall, exercising earlier may be better.
- Liquidity events: If a sale or IPO is on the horizon, exercising in advance may make tax sense.
- Expiration: Stock options usually have an expiration date (typically 7-10 years from grant). If you do not exercise them before then, you lose them.
⚠️ Important: Stock options have an exercise price (strike price). If the company's value does not exceed that price when you want to exercise, the option may have no practical value. In addition, if you leave the company before vesting is complete, you lose the unvested options.
🚨 Common mistake: Many employees do not exercise their stock options because they do not have the money to pay the strike price. However, some companies allow simultaneous exercise and sale (cashless exercise), or you can seek external financing. Not exercising valuable options is leaving money on the table.
Phantom Shares: Sharing in Success Without Being a Partner
Phantom shares (or virtual shares) work differently. Here there is no real participation in capital and no purchase option. Instead, there is a bonus that is calculated based on how the company's value evolves.
With phantom shares:
- You do not enter the company's capital (you do not appear in the Commercial Registry)
- You have no voting rights and no participation in decisions
- You are not diluted in future investment rounds
- But if the company does well, you receive a bonus proportional to the value you have "earned"
- If there is an exit (sale or IPO), you also share in the proceeds according to your virtual percentage
How Phantom Shares Work
Phantom shares are a contract between the company and the employee that sets out:
- Number of "virtual shares": You are assigned, for example, the equivalent of 0.5% of the company's value
- Liquidation event: Defines when the value is calculated and paid (sale of the company, IPO, specific milestone, etc.)
- Calculation formula: Sets how the value is calculated (typically: company value × your virtual percentage)
- Conditions: May include vesting, tenure conditions, etc.
Practical Example
Phantom shares granted
0.5%
of the company's value
Sale of the company (5 years later)
€20M
Your bonus
€100,000
(€20,000,000 × 0.5%, before taxes)
Advantages of Phantom Shares
- They do not modify the cap table: The corporate structure stays intact, which is important for future investment rounds.
- Flexibility: They can be structured in many different ways to fit the company's needs.
- Simplicity: They do not require amendments to the bylaws or filings with the Commercial Registry.
- No dilution for other shareholders: Existing shareholders are not diluted because no new shares are issued.
- Control: The company keeps full control over when and how they are paid out.
Tax Considerations for Phantom Shares
Phantom shares are treated as employment income when paid:
- Upon receiving payment: The bonus is treated as employment income and taxed under IRPF on the general scale (up to 45% in the top brackets).
- No special exemption: Unlike stock options in emerging companies, phantom shares have no special tax exemption.
- Timing: You are only taxed when you receive the money, not when the phantom shares are "earned".
When to Use Phantom Shares
Phantom shares are ideal when:
- You want to incentivize a broad team without modifying the cap table
- You already have investors and you do not want to dilute the capital further
- You need flexibility to structure incentives in a tailored way
- You want to reward specific results or concrete milestones
- The company is not ready to issue real shares (for example, at a very early stage)
💡 Key advantage: Phantom shares work great for rewarding the team without disrupting the corporate structure. They are especially useful when you want to incentivize without modifying the cap table. In addition, since there is no real shareholding, the employee does not have to worry about dilution issues or share management.
⚠️ Important consideration: Phantom shares depend on the company honoring the contract. If the company lacks liquidity when payment is due, or if there are changes in management, the payout may be compromised. It is important to have a well-drafted contract that protects your rights.
Comparison: Equity vs. Stock Options vs. Phantom Shares
The million-dollar question is: which of these three options is best? The honest answer is: it depends. It depends on who, what for, and at what stage your startup is.
| Feature | Equity | Stock Options | Phantom Shares |
|---|---|---|---|
| Real capital participation | ✓ | ! | ✗ |
| Voting rights | ✓ | ! | ✗ |
| Modifies cap table | ✓ | ! | ✗ |
| Dilution in future rounds | ✓ | ! | ✗ |
| Taxation upon receipt | ! | ✗ | ✗ |
| Taxation upon exercise/sale | Capital gain |
Employment income + capital gain |
Employment income |
| Tax exemption (emerging co.) | ✗ | €50K | ✗ |
| Liquidity required to exercise | N/A | ✓ | N/A |
| Legal complexity | Med-High | Medium | Low |
| Best for | Co-founders | First employees | Broad teams |
For Founders: What to Consider
As a founder, choosing the right type of incentive is crucial for long-term success:
Equity
The Ultimate Commitment
Co-founders, key first strategic hires
Co-founders: 20-50%
CTO/VP: 1-3%
Key employees: 0.5-2%
Stock Options
The Perfect Balance
First employees, talent to retain
Employees 1-10: 0.25-1%
Employees 11-50: 0.1-0.5%
Later hires: 0.05-0.25%
Phantom Shares
Flexibility
Broad teams, without further dilution
Broad teams: 0.01-0.1%
Milestone bonuses: variable
For Employees: What to Understand and What to Negotiate
If you are an employee and you are offered participation, it is crucial to understand what you are receiving:
If You Are Offered Equity
✅ Advantages
- • You are a real shareholder with legal rights
- • The most valuable option long-term
- • You appear in the Commercial Registry
❓ Key questions
- • What exact percentage?
- • Is there vesting?
- • Exit clauses?
- • Tax implications?
If You Are Offered Stock Options
✅ Advantages
- • Future right to become a shareholder
- • Tax benefits (emerging company)
- • No impact on cap table until exercise
❓ Key questions
- • How many options? Strike price?
- • When do they expire?
- • Is there vesting?
- • Certified emerging company?
💡 Negotiate:
A low strike price (or €0) and a long exercise period (7-10 years)
If You Are Offered Phantom Shares
✅ Advantages
- • You share in the success
- • Simpler than equity
- • No dilution for you
❓ Key questions
- • What virtual percentage?
- • When are they paid?
- • What happens if I leave?
- • Is the contract well drafted?
💡 Negotiate:
A higher percentage and a clear contract on when and how it is paid
Common Mistakes to Avoid
Both founders and employees make common mistakes when structuring or receiving incentives. Here are the most important ones:
Founder Mistakes
-
❌
Not documenting properly
Granting equity or options without a clear, well-drafted contract is a serious mistake. Everything must be in writing.
-
❌
Not considering future dilution
If you give away too much equity now, you may not have enough left for future rounds or to attract more talent.
-
❌
Not explaining it clearly to employees
Many employees do not understand what they have. This breeds frustration and can lead to conflicts.
-
❌
Vesting too short or too long
A 1-year vesting is too short. A 10-year vesting is too long. The standard is 4 years with a 1-year cliff.
-
❌
Not reserving an ESOP
It is essential to reserve a pool (10-20% of capital) for future employees before the first round.
Employee Mistakes
-
❌
Not asking enough questions
Accepting options without understanding what you have. Ask about: percentage, strike price, vesting, expiration, current value.
-
❌
Not exercising valuable options
If your options have value and you can exercise them, do it. Failing to exercise valuable options means leaving money on the table.
-
❌
Not considering tax implications
Exercising options or receiving equity has tax consequences. Plan ahead.
-
❌
Assuming they will always be worth something
Most startups fail. Your options may end up being worth nothing. Do not base important financial decisions on unexercised options.
-
❌
Not reading the contract
Read the entire contract, especially the exit and expiration clauses and what happens if you are dismissed or resign.
Best Practices
For Founders
-
✓
Reserve a 10-20% ESOP
Before the first round, reserve a pool for employees. This prevents founders from being diluted with every new hire.
-
✓
Use standard vesting
4 years with a 1-year cliff is the industry standard. Do not reinvent the wheel.
-
✓
Document everything
Each grant must be documented with a clear contract setting out rights, obligations, vesting and conditions.
-
✓
Educate your team
Organize sessions to explain what they have, how it works and what they can expect. Transparency builds trust.
-
✓
Consider ENISA certification
If your startup can be certified as an emerging company, your employees will benefit from tax exemptions on stock options.
For Employees
-
✓
Ask everything
Do not be afraid to ask. It is your right to understand what you are receiving.
-
✓
Negotiate the strike price
If you can, negotiate a low strike price or even €0. This makes exercising easier.
-
✓
Plan for liquidity
If you have stock options, plan how you will obtain the money to exercise them when the time comes.
-
✓
Consider tax timing
Exercising options has tax consequences. Consult a tax advisor to optimize the timing.
-
✓
Do not base decisions on unexercised options
Options may be worth nothing. Do not make important financial decisions assuming they will be worth something.
Frequently Asked Questions
Can I have equity and stock options at the same time?
Yes, it is possible. For example, a co-founder can hold direct equity and also receive additional stock options as part of an incentive plan. However, it is less common and must be well documented to avoid confusion.
What happens to my stock options if I am dismissed?
It depends on the contract. Typically, if you are dismissed without cause, you can exercise the options that have already vested within a defined period (usually 90 days). If you resign, the period may be shorter. If you are dismissed with cause, you may lose all options. It is crucial to read your contract.
Can phantom shares be converted into real equity?
Not automatically. Phantom shares are a bonus contract, not real participation. However, some companies offer the possibility of "converting" phantom shares into real equity under certain conditions, but this requires an amendment to the contract and to the cap table.
How much equity should I give to a co-founder?
There is no fixed rule, but co-founders typically share 60-80% of the total equity (reserving 20-40% for future employees and investors). The split depends on who had the idea, who brings the most value, who invests capital, etc. It is essential to have a shareholders' agreement that regulates this.
Which is better from a tax perspective: equity, stock options or phantom shares?
For ENISA-certified emerging companies, stock options have significant tax advantages (an exemption of up to €50,000 per year). Direct equity is taxed upon receipt if it is given as consideration for work. Phantom shares are taxed as employment income when paid. Overall, stock options in emerging companies are usually the most tax-advantageous.
Can I sell my shares before an exit?
It depends. If you hold real equity, you can technically sell it, but there are usually restrictions in the bylaws or in the shareholders' agreement (right of first refusal, pre-emptive rights, etc.). Stock options cannot be sold until they are exercised. Phantom shares cannot be sold because they are not real shares.
🔗 Related services
Need help structuring your team's incentive scheme?
At Satya Legal, we specialize in designing incentive systems (equity, stock options, phantom shares) that adapt to your startup's needs and your team's expectations. We can help you structure these programs optimally and on solid legal ground.
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