Throughout this process, the employee never owned shares, but they received the same economic benefit in cash. “Unlike stock options or RSUs, phantom equity provides cash-settled upside without granting ownership,” Patel said. “This preserves the existing ownership structure while still providing meaningful incentives.”

Phantom equity vs. traditional equity

While phantom equity and traditional equity both serve to align employee incentives with company performance, they differ significantly in structure, administration and strategic impact.

• Ownership and dilution: Traditional equity grants actual ownership stakes, creating voting rights and board representation considerations. Phantom equity provides economic upside without ownership transfer or dilution.
• Settlement method: Stock options and RSUs typically settle in shares, requiring employees to hold equity positions or navigate sale processes. Phantom equity pays cash directly. “Many execs are increasingly favoring phantom equity because it’s clearer, cleaner and more liquid than traditional options—especially in private companies with long liquidity timelines,” Patel said.
• Administrative complexity: Traditional equity requires ongoing cap table management, securities law compliance and shareholder communications. Phantom equity operates more like deferred compensation, with simpler regulatory requirements but different tax considerations.
• Flexibility in structure: Phantom equity allows companies to customize payout triggers, performance metrics and vesting schedules without securities law constraints that govern traditional equity grants. This flexibility proves particularly valuable for companies with complex ownership structures or specific strategic objectives.

When to use phantom equity

Phantom equity works best in specific scenarios where traditional equity grants create structural challenges or strategic conflicts. Understanding these use cases can help companies determine when phantom equity offers the most strategic value.

• Entity structure limitations: “Phantom equity is particularly useful in S-corps and LLCs that can’t easily issue shares,” Patel said. These entity structures face regulatory constraints on share issuance, making phantom equity a practical alternative for incentive compensation.
• Ownership preservation priorities: Founder-led or closely held companies often prioritize maintaining control. “In today’s tougher fundraising environment, phantom equity is an increasingly valuable tool to protect founders and early investors from unnecessary dilution,” Patel said. “When rounds are taking longer to close or valuations are compressed, it allows startups to stay competitive on executive compensation without giving away ownership too early or too cheaply.”
• Cap table sensitivity: Seed-stage or Series A companies frequently face pressure to preserve equity for future funding rounds. Phantom equity enables competitive compensation without further diluting existing shareholders during critical growth phases.

“It’s not a workaround. It’s a way to compete without compromise—to retain control while offering meaningful upside to the people who move the business forward,” she said.

How phantom equity aligns compensation to business objectives

• Go-to-market and sales leadership: “Phantom equity can mimic the upside of equity while tying payouts directly to metrics like revenue growth, customer acquisition or market expansion,” Patel said.
• Strategic partnerships and business development: Phantom equity often proves valuable in pre-revenue stages when business development roles drive key partnerships but traditional equity compensation may not align with these mission-critical objectives.
• Chief financial officers: Phantom equity enables long-term incentive alignment based on capital efficiency, profitability or financing outcomes, with cleaner tax implications than stock options.
• Non-founder executives: “Phantom equity is a great solution for attracting senior leadership without giving up ownership, governance rights or equity complexity,” Patel said.

A former founder and investor herself, Patel said she has seen phantom equity resonate well with seasoned operators who value certainty and liquidity. “They’re focused on real upside and alignment with clear payout mechanisms,” she said.

Communicating the value proposition of phantom equity to executives

How companies position phantom equity significantly impacts executive reception and buy-in. Patel identified a few of the most effective messages she’s encountered while working with startups:

• Immediate value: “You’re earning real value, not just speculative paper.”
• Performance alignment: “This structure rewards performance and pays out on results.”
• Risk mitigation: “You’re aligned with long-term outcomes without taking on unnecessary risk.”

This messaging resonates particularly well with experienced executives who value compensation certainty alongside performance upside, Patel said. The key is emphasizing the guaranteed nature of the payout mechanism while maintaining the excitement of equity-like appreciation.

Important phantom equity considerations

While phantom equity offers strategic advantages, companies must carefully plan for specific challenges that can impact both implementation and long-term success.

• Cash flow planning: Unlike equity grants that transfer value through shares, phantom equity creates direct cash obligations when triggering events occur. Companies must model and plan for potentially significant cash outflows, especially during exit scenarios where multiple employees may vest simultaneously.
• Valuation and disclosure: “From an investor perspective, phantom equity is rarely a red flag—as long as it’s modeled properly, governed cleanly and disclosed early,” Patel said. “Problems arise when liabilities are undocumented, misunderstood or misaligned with strategy.” Companies need clear valuation methodologies and transparent communication with existing investors.
• Design sophistication: Poor plan design can create unintended consequences, misaligned incentives or administrative burdens that undermine the strategic benefits.
• Limited ownership mindset: Employees receive economic benefits without actual ownership stakes, which may reduce the psychological ownership and long-term commitment that traditional equity holders often develop. Companies should consider how to maintain engagement and alignment beyond pure financial incentives.

Getting started with phantom equity

Successfully implementing phantom equity requires strategic planning across multiple dimensions, from initial design through exit scenarios.

Essential design principles

“Phantom equity only works if it’s designed for scale and built to align,” Patel said. Companies can focus on creating structures that support long-term growth while maintaining clear performance incentives.

Key considerations include linking compensation to meaningful business metrics, establishing clear triggering events for payouts and ensuring the plan remains viable through different growth stages and potential exit scenarios.

Tax and financial planning

Phantom equity creates different tax implications than traditional equity compensation. “Beyond the ordinary income treatment, the bigger questions for execs often include ‘When does it pay out? How predictable is that payout? How does this fit into my broader comp and financial plan?’” Patel said.

Companies considering phantom equity should work with tax professionals to understand timing implications, while employees may want to consider how phantom equity payouts integrate with personal financial planning and liquidity needs.