Phantom Share Arrangements

Commercial, tax-aware and flexible incentive schemes for growing UK businesses

Phantom share arrangements (also known as phantom equity plans, phantom share options or cash-settled share schemes) allow you to reward key people based on the growth in your company’s value, without issuing actual shares or diluting equity. They can align incentives, support retention and drive long-term performance, while keeping your cap table clean and ownership under control.

These are cash-based schemes, not equity awards. Payouts are typically taxed as employment income through PAYE and National Insurance at the point of payment, rather than as capital gains. For many companies and staff, this can actually be advantageous, as it avoids complex share-based tax issues and keeps the incentive structure straightforward to administer.

At Jonathan Lea Network, our solicitors design, draft and implement phantom share schemes for startups, scale-ups, SMEs, high-growth tech companies and established businesses across England and Wales. We combine corporate, tax and employment expertise to create arrangements that are legally robust, commercially sensible and easy to explain to participants.

Our team, based in Sussex and London, is known for being approachable, proactive and transparent on fees. We work collaboratively, so you benefit from senior expertise supported by efficient delivery, giving strong value for money.

Speak to a phantom share solicitor today. Call us on 01444 708 640 or complete our online enquiry form to arrange a free introductory call. 

What are phantom shares and why do businesses use them?

Understanding phantom share arrangements.

A phantom share arrangement is a contractual scheme under which employees or other participants receive a cash bonus linked to the value (or increase in value) of the company’s shares, without being issued any actual shares. Participants may be granted a notional number of “phantom” shares, or a percentage interest, which tracks the underlying equity value over time.

Key characteristics of phantom shares.

• No actual shares are issued, so participants do not acquire voting rights, dividend rights or formal shareholder status.
  
• Payments are typically made in cash, often triggered by an exit event, vesting date or performance milestone.
  
• The value of the award is normally referenced to the company’s share value or a formula derived from financial performance.
  
• The arrangement is governed by contract law, rather than company law rules on share capital.
  

Why businesses choose phantom shares.

• Motivating and retaining key people. Phantom shares give staff a clear personal stake in the company’s success, which can significantly improve motivation, retention and alignment of interests with founders and investors.
  
• Avoiding equity dilution and cap table complexity. Because no real equity is issued, your share register stays simple and existing shareholders retain full ownership and voting control. This is especially attractive before fundraising or when you are managing complex investor rights.
  
• Aligning rewards with exit or long-term growth. Many plans pay out only on a sale, listing or other liquidity event. This encourages a long-term mindset and ensures rewards are closely tied to value creation.
  
• Bridging negotiations with senior hires. Where equity is not yet available, or investor negotiations are ongoing, a phantom share arrangement can bridge expectations with senior hires or key technical staff in a way that is still meaningful and credible.
  
• Offering incentives when share-based schemes are impractical. Phantom share plans are useful where EMI or other share option schemes are not available or appropriate, for example because of company size, trade restrictions, international teams or investor sensitivities.
  

Where significant payout obligations are anticipated, it remains essential to align phantom schemes with your shareholder agreements, obtain board and (where necessary) shareholder approvals, and carry out careful cash-flow planning in advance.

How phantom share schemes work

Full-value vs appreciation-only awards.

Broadly, phantom share schemes are structured in one of two ways:

• Full-value phantom shares. Participants receive a cash amount equal to the full notional value of their phantom shares at the time of payout, similar to owning real shares that are cashed out on exit. This can be attractive where you want staff to feel like genuine value-shareholders.
  
• Appreciation-only phantom shares. Participants receive only the increase in value since grant, rather than the full value. This structure reduces cost for the company, while still strongly aligning incentives with growth in enterprise value.
  

Typical payout triggers.

• Exit events such as a sale of the company, group reorganisation or IPO.
  
• Pre-defined performance milestones, such as revenue, profit or project-based targets.
  
• Time-based vesting events, for example after three or five years of continuous service.
  
• Discretionary events, subject to clear rules and governance, for example board decisions following a partial sale or refinancing.
  

In UK practice, HMRC generally treats phantom share payouts as employment income in the year of payment, taxed through PAYE and subject to employer and employee National Insurance contributions, much like a cash bonus.

While businesses have broad flexibility to structure phantom plans, they must still comply with general contract law, employment protections, tax rules and, for certain sectors, any applicable regulatory regimes. We design schemes that respect these constraints while giving you the commercial flexibility you need.

Why choose phantom shares instead of issuing real shares or options?

Comparing phantom shares with actual equity or share options.

Phantom share arrangements offer a number of distinct advantages compared with issuing shares or granting options such as EMI or unapproved options:

• No change to the cap table. Phantom awards do not require adjustments to issued share capital or creation of new share classes. This keeps your company structure straightforward, which investors often prefer, particularly in earlier rounds.
  
• No dilution of founder or investor ownership. Because participants do not own actual equity, your existing shareholders’ percentage holdings and voting power remain unchanged. The economic cost is borne through cash payouts, which can be planned for and negotiated.
  
• Simplified cross-border incentives. Where you have international staff, phantom shares avoid many securities-law and share-plan complications across jurisdictions. That said, local employment and tax rules in each country must still be considered, and we coordinate with local advisers where necessary.
  
• Valuation flexibility without statutory approval. Unlike certain tax-advantaged options, there is no requirement for HMRC-approved valuations. However, using a clear, defensible valuation methodology helps reduce the risk of HMRC challenge and gives participants confidence in how their awards are calculated.
  
• Greater contractual flexibility. Phantom plans are built on contract rather than statute. This often allows more tailored vesting conditions, performance gates, leaver provisions, good/bad leaver distinctions and clawback mechanisms than would be practical with standard option schemes.
  

Phantom share arrangements are not a tax-advantaged substitute for EMI, but they are a powerful commercial alternative where EMI is not available or would not deliver the desired balance of control, flexibility and simplicity.

When are phantom shares the right choice?

Situations where phantom share schemes fit well.

• Founders wanting to retain full control and avoid dilution. Phantom plans allow you to share in financial upside without sacrificing equity. This is particularly relevant pre-funding or where investor rights are carefully negotiated.
  
• Businesses with complex group or investor structures. Where you have multiple subsidiaries, preference shares, ratchets or investor protections, issuing equity or options can become difficult. Phantom shares sit outside the share structure and can be easier to implement.
  
• Companies planning for an exit in the medium term. Exit-only phantom schemes align the team with a sale or listing, while giving investors and founders confidence that rewards are tied to a successful exit.
  
• Scale-ups that cannot (or do not wish to) use EMI options. EMI requires specific UK eligibility criteria around size, trading activities, independence and working time. Phantom schemes are not tax-advantaged, but they are flexible and can be tailored for participants or entities that fall outside EMI rules.
  
• Mature businesses wanting predictable cost and governance. Because phantom awards pay out in cash, companies can model the potential cost, build it into budgets, and manage the timing of payouts in line with liquidity events.
  

We help you decide whether phantom shares, EMI, unapproved options, direct equity or a hybrid structure will best meet your objectives, and we explain the pros and cons of each in plain English.

Step 1: Understanding your business, governance and tax position

Clarifying your commercial and incentive goals.
We start by understanding why you want a phantom scheme and what success looks like for you. Are you trying to incentivise a small senior team, retain key engineers, reward a broader group of staff, or prepare for a future exit? Your goals drive design choices.

Reviewing your corporate structure and stakeholder expectations.
We review your share capital, shareholder agreements, investor term sheets and group structure. This ensures the phantom plan fits the existing framework, respects investor protections and does not undermine important rights or waterfall arrangements.

Assessing tax treatment and cash-flow impacts.
We explain the expected tax treatment for participants (typically PAYE and NIC on payout), and for the company (payments usually deductible as employment costs for corporation tax purposes, if structured correctly). We also help you assess the potential cash-flow impact at different value scenarios so there are no surprises.

Identifying regulatory and sector-specific considerations.
In regulated sectors, or where schemes start to look like derivative products, we consider whether the structure risks falling within the perimeter of financial regulation. We design the plan as an employment-related cash bonus mechanism, so it remains firmly on the incentive side rather than financial instrument side.

This initial assessment gives you a clear, joined-up view of commercial, tax and governance implications before committing to a scheme design.

Step 2: Designing your phantom share scheme

Structuring awards and participation.
We help you choose between full-value and appreciation-only awards, and decide who should be eligible. You might want to start with a small senior pool, expand later, or offer different levels for different roles. Clarity here helps manage expectations and cost.

Setting vesting rules and performance conditions.
We work with you to set time-based and/or performance-based vesting conditions. For example, awards might vest over three to five years, with additional hurdles such as revenue targets, profitability milestones or non-financial KPIs. This ensures participants are rewarded for sustained contribution over time.

Defining payout events and formulae.
We help you decide when awards crystallise and how they are calculated. This may involve:

• Exit-only payouts, where awards pay out on a sale or listing.
  
• Periodic valuations, for example every one to three years, with partial cash-outs.
  
• Formula-based approaches such as EBITDA multiples, adjusted profit measures or hybrid methods.
  

Leaver provisions and good/bad leaver rules.
Clear leaver provisions are critical. We draft definitions and consequences for good leavers (such as redundancy, ill-health or retirement) and bad leavers (such as gross misconduct or voluntary resignation before vesting). This clarity reduces disputes and protects the business if someone leaves at a sensitive time.

Clawback and malus mechanisms.
We can include clawback provisions under which awards can be reduced or recovered if, for example, financial results are restated, misconduct is discovered or regulatory issues arise. These mechanisms are increasingly common in UK incentive arrangements and can be essential for governance and investor comfort.

Design decisions are made collaboratively, so the final scheme reflects your culture, risk appetite and strategic priorities.

Step 3: Drafting scheme rules and individual agreements

Preparing the core plan rules.
We draft a set of phantom scheme rules that define how the plan operates, including eligibility, vesting, valuation, payout triggers, leaver provisions, adjustments for corporate events and dispute resolution. The rules are written in clear language but grounded in sound legal drafting.

Individual award letters or agreements.
Each participant receives a tailored award document setting out their allocation, vesting conditions, and any specific terms. This gives certainty and avoids misunderstandings about what each person is entitled to.

Board and shareholder approvals.
Where appropriate, we prepare board minutes and, if necessary, shareholder resolutions approving the scheme and authorising the company to enter into the relevant obligations. This supports good corporate governance and evidences that the scheme has been properly approved.

Valuation frameworks and documentation.
We work with your finance team or external accountants to establish a robust valuation method. For some companies this may be based on independent valuation; for others, a formula linking to profit, revenue or agreed multiples. Documenting the method upfront reduces scope for later disagreement and supports HMRC compliance if the valuation is reviewed.

Step 4: Implementation, communication and ongoing maintenance

Clear communication with participants.
We help you present the scheme to participants clearly and positively. Well-delivered internal communications can significantly increase the motivational effect; poorly explained plans risk confusion or scepticism.

Ongoing administration and annual checks.
We advise on maintaining accurate records of awards, vesting, valuations and payouts. This supports internal governance, helps with due diligence in future funding rounds or exits, and provides an audit trail for HMRC.

Updating the scheme as your business evolves.
As your company grows, raises capital or changes strategy, your incentive needs may shift. We can update the plan rules or introduce new tranches, making sure everything remains aligned with your corporate and tax position.

Preparing for due diligence and exit.
Phantom schemes are frequently scrutinised in due diligence. We ensure documentation is clean, consistent and clearly explains how liabilities are calculated and paid, reassuring potential buyers or investors.

Who we help with phantom share arrangements

Startups and high-growth scale-ups.
We assist founders who want compelling incentives to attract and retain top talent before equity-based schemes like EMI are fully practical or available. Phantom plans allow them to offer “skin in the game” without overcomplicating the cap table at an early stage.

Private companies with complex ownership structures.
Where there are preference shares, ratchets, multiple subsidiaries or investor rights, equity awards can be difficult and sensitive. Phantom share schemes allow you to reward people at group or operating-company level without re-opening shareholder negotiations.

Founders and shareholders planning for exit.
We work with owner-managers who want to share a portion of exit proceeds with key team members, while maintaining equity control until the exit. Phantom plans can be structured to pay out from sale proceeds in a transparent, pre-agreed way.

Established SMEs looking to retain senior staff.
Growing SMEs often reach a stage where traditional bonuses no longer align well with long-term value creation. Phantom schemes can encourage retention and sustained performance across senior teams, without issuing new shares.

Technology and innovation businesses.
Tech and IP-rich businesses, where ownership and control of intellectual property is critical, often find phantom shares particularly attractive. They enable strong incentives while avoiding complicated IP assignment or equity dilution issues.

Senior executives and key hires.
We also advise individuals offered phantom share arrangements as part of their remuneration package, explaining the legal and tax implications and helping them negotiate fairer terms where appropriate.

Common challenges and how we help solve them

“We want to incentivise staff but cannot dilute the existing shareholders.”
We design phantom schemes that provide meaningful upside linked to company value without creating new shares or altering the ownership structure. This balances staff motivation with investor and founder control.

“We are too early or ineligible for EMI, but we still want a compelling incentive.”
We implement phantom arrangements that act as a flexible, commercial alternative to EMI, suitable for companies that do not meet EMI criteria or want more contractual flexibility, while clearly explaining the different tax treatment.

“We need a robust valuation and payout framework that investors will accept.”
We help you choose a defensible valuation methodology—whether formula-based or valuation-based—and build it transparently into the scheme documentation. This reduces friction with investors and participants when payouts are due.

“We are worried about leaver disputes and people leaving just before an exit.”
We draft clear good leaver/bad leaver provisions and tie vesting and payout rights to appropriate conditions. This reduces scope for argument and ensures that rewards go to those who have genuinely contributed to value creation.

“We are concerned about regulatory and FCA issues.”
We structure phantom schemes as employment-related cash bonus arrangements, not tradable derivatives, so that they do not ordinarily fall within the scope of financial services regulation. Where your structure is more complex or might approach the regulatory perimeter, we highlight this early and design the plan to stay safely outside regulated activity.

Tax and compliance overview

Tax treatment for participants.
Phantom share payouts are normally taxed as employment income in the tax year they are paid, via PAYE, with employee National Insurance contributions due in the usual way. Participants should be aware that this is different from the capital gains tax treatment which can apply to certain share options or direct shareholdings.

Corporation tax and employer obligations.
For the company, phantom share payouts are typically deductible as staff costs, subject to general corporation tax rules. Employer National Insurance contributions may be payable, and the company will need appropriate payroll processes to handle these amounts at payout.

Employment-related securities reporting.
Because phantom shares do not involve issuing or acquiring securities, they usually do not fall within the employment-related securities reporting regime. However, care must be taken where arrangements interact with actual equity or convert into shares at any point.

Governance and documentation.
Good record-keeping is essential. We help you maintain clear records of awards, valuations, board approvals and payouts, supporting internal governance, HMRC compliance and the due diligence process for future investors or buyers.

Regulatory perimeter.
Most phantom schemes are structured so they are not regulated investments under the Financial Services and Markets Act 2000. Where there is any risk that a particular structure might be viewed as a contract for differences or similar instrument, we advise on how to modify the design so that it remains a straightforward employment incentive arrangement.

Why choose Jonathan Lea Network for phantom share schemes?

Integrated corporate, tax and employment expertise.
Our team brings together corporate, commercial, tax and employment lawyers who are experienced in employee incentives, ensuring your scheme is cohesive and practical rather than narrowly drafted.

Clear, accessible communication.
We explain complex incentive mechanics in straightforward language, so directors, employees and investors understand how the scheme works and what it is meant to achieve. This reduces misunderstandings and increases buy-in.

Tailored, commercially focused solutions.
We do not simply drop in a template. We design each phantom share scheme around your business model, investor landscape, growth aspirations and culture, ensuring real-world fit.

Transparent fees and value for money.
We offer fixed-fee packages for standard scheme design and documentation where possible, and provide clear, upfront cost estimates for more complex or bespoke projects. You know where you stand from the outset.

Long-term support and adaptability.
We stay involved as your business grows, helping you adjust your scheme, add new layers or transition to equity-based arrangements as appropriate.

What to do now

If you are considering a phantom share scheme—or want to review, update or replace an existing incentive plan—taking early advice will help you avoid pitfalls and maximise the benefits.

All enquiries are confidential. Once instructed, our advice is generally protected by legal professional privilege.

Contact us:

• Email: wewillhelp@jonathanlea.net
• Phone: 01444 708640
• Make an enquiry online

Unlock your company’s potential. Reward future success. Protect your business.

Photo by Look Studio on Unsplash