Startup incentive plans: shares, options or phantom shares?

Begin by defining the purpose of the plan

An incentive plan may be designed to retain key people, recruit an expert, reward a specific achievement or align the team with a planned sale of the company.

These objectives require different structures. A person building a product over several years may acquire rights gradually. An adviser engaged for one stage may be rewarded after achieving a milestone. A management board member may participate in a bonus linked to the company's value when an investor exits.

Only after the objective has been defined can the founders decide whether to use shares, options, simple joint-stock company shares or a phantom-share arrangement.

• whether the participant should become an actual shareholder;
• whether the participant should have voting and information rights;
• whether the company intends to pay cash or transfer shares;
• when the entitlement should vest;
• what happens when the participant leaves;
• how the plan will affect a future funding round.

Actual shares mean joining the company

A person who receives shares in a Polish limited liability company becomes a shareholder. They may obtain rights to dividends, participation in shareholders' meetings, information and a share of the proceeds when the company is sold.

The shares may be transferred by the existing founders or created through a share-capital increase. Each route requires an appropriate corporate procedure and should comply with the articles of association and the shareholders' agreement.

Future work or services cannot be used as a contribution for shares in a limited liability company. A resolution stating that an employee takes up shares in exchange for work to be performed over the next three years is therefore insufficient. The structure must account for the required contribution and the conditions for acquiring the shares.

The admission of a new shareholder should be coordinated with transfer restrictions, pre-emption rights, drag-along and tag-along provisions and decision-making rules.

An option is a right to acquire shares in the future

Under an option plan, the participant does not have to become a shareholder immediately. Instead, they receive a right to acquire a specified number of shares after satisfying the applicable conditions.

Granting an option does not mean that the participant already owns shares. Until exercise, the participant does not vote as a shareholder and generally does not participate in dividends.

The company should ensure that it can deliver the promised shares when the plan is exercised. If the entire mechanism relies only on a founder's general assurance, a dispute may arise precisely when the business has become significantly more valuable.

• the number of shares or the method for calculating it;
• the exercise price;
• the vesting schedule;
• the conditions for exercise;
• the exercise period;
• the source of the shares and required corporate approvals;
• the consequences of termination;
• the rules applying when the company is sold.

Phantom shares are not shares

A phantom-share plan can reproduce the economic result of owning shares without adding the participant to the ownership structure.

The participant receives a claim for a cash bonus calculated by reference to the value of the company, the price achieved in a transaction or another agreed measure. They do not become a shareholder and do not automatically receive voting or other corporate rights.

The documents must define the payment calculation precisely. A reference to 'company value' is insufficient if it is unclear whether this means equity value or enterprise value, how debt and later funding rounds are treated and how deferred consideration, earn-outs and escrow are handled.

Phantom shares may reduce corporate complexity, but they create a cash liability for the company. Their accounting and tax treatment and the effect of a future payment on liquidity should be assessed before the plan is launched.

A simple joint-stock company offers more flexibility

Shares in a Polish simple joint-stock company, or PSA, may be taken up in exchange for work or services. This is an important difference from a limited liability company.

A PSA offers greater flexibility in creating classes of shares, preferences and issue rules. It may therefore suit a venture that plans a broad employee shareholding structure from the outset.

The grant of shares does not resolve every issue. The parties must define the value and scope of the participant's services, performance deadlines, registration in the shareholder register and the consequences of non-performance. Founders should also regulate the participant's corporate rights and obligations in a future transaction.

Vesting determines when entitlements are earned

Vesting protects the company from granting the entire package at the outset to a participant who then leaves shortly afterwards.

A common model provides for vesting over four years, with the first portion acquired after one year. This is neither mandatory nor always appropriate. The schedule should reflect the participant's role and the company's stage of development.

Rights may vest over time, when performance targets are met, after a product milestone or under a combination of time and measurable goals. The documents should also address whether a notice period, long absence or suspension of cooperation affects vesting.

Good leaver and bad leaver should not be empty labels

Plans often provide more favourable treatment for a person leaving for reasons outside their control and less favourable treatment for a participant who breached the agreement or resigned soon after receiving an award.

Using the terms 'good leaver' and 'bad leaver' is not enough. The documents must identify specific events and consequences. An overly general or excessively one-sided mechanism increases the risk of a dispute when a key person leaves.

• what happens to the unvested portion;
• whether the participant retains vested rights;
• whether the company or founders may repurchase shares;
• the repurchase price;
• how long the participant has to exercise an option;
• which breaches justify less favourable treatment.

A company sale may accelerate the plan

In a transaction, an investor will usually want to know how much of the plan has been awarded, how many rights may be exercised and how this will affect the ownership structure.

The plan may accelerate vesting when the company is sold. Acceleration may cover the entire remaining package or only a portion. It can also depend on a second event, such as termination of the participant's engagement after the acquisition.

The documents should determine whether the participant must sell alongside the founders, join the transaction documents and accept the protections included in them. A poorly organised plan can complicate due diligence and delay closing.

Dilution must be calculated

A statement that the participant will receive '1% of the company' is ambiguous unless the number of shares used to calculate that percentage is clear.

The documents should state whether the percentage is calculated before or after creating the entire pool or on a fully diluted basis assuming that all awarded options are exercised. They should also address how future issues and funding rounds affect plan participants.

An investor may require the employee pool to be established before the investment. In practice, this may mean that the economic cost of the plan is borne mainly by the existing founders.

Tax and social security require review before awards are granted

The tax consequences depend on the instrument, the participant's status and residence and the timing of grant, exercise and sale.

Polish tax law contains specific rules for certain share-based incentive plans, but not every option plan or arrangement involving shares in a limited liability company automatically qualifies. Phantom shares are cash benefits whose treatment also depends on the legal basis of the participant's engagement.

The tax analysis should be completed before the documents are signed. A later change to the structure may alter the economic result promised to participants.

What documents are required?

A complete plan may require plan rules, corporate resolutions, individual award agreements and amendments to the articles of association or shareholders' agreement.

The documentation should be consistent with employment and B2B agreements, confidentiality rules, intellectual-property assignments and non-compete restrictions.

An incentive plan does not replace a valid assignment of rights to code, designs or know-how. A participant may be entitled to a bonus or shares while the company still lacks essential rights to the product they created.