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Most owners don’t truly want to give away equity.

They want:

• Accountability
• Long-term thinking
• Profit focus
• Loyalty
• Enterprise value growth

That’s an incentive design issue — not an ownership issue.

If compensation moves with performance and value, behavior follows. Research from Harvard supports this idea — that treating employees like owners drives better outcomes.

Phantom stock is often the cleanest solution for private companies.

You grant “units” that mirror company shares. Those units increase in value as the company’s valuation increases. When a triggering event occurs (sale, retirement, or scheduled payout), the employee receives cash equal to the value of those units.

They benefit from growth in company value — but they never own actual equity.

Why this works so well in closely held businesses:

• No voting rights
• No minority shareholder protections
• No buy-sell complications
• No dilution of family ownership
• You control the payout timing

Tax considerations:

• The employee is generally taxed at ordinary income rates when the payout is received.
• The company typically gets a tax deduction when it pays.
• No capital gains treatment for the employee — but no up-front buy-in requirement either.

For a deeper dive, see our Phantom Stock Whitepaper.

SARs are similar to phantom stock but more focused. See how performance units and phantom stock compare.

Instead of paying the full value of a share, you only pay the increase in value from the grant date.

If your company grows from $8 million to $20 million over five years, the employee shares in that growth — not the original base value.

Tax impact:

• Taxed as ordinary income when paid.
• Deductible to the company at that time.

Performance-based compensation tied to measurable metrics can dramatically shift behavior in privately held businesses.

Common metrics in closely held companies:

• EBITDA
• Net income
• Gross margin
• Revenue growth
• Cash flow
• Department profitability
• Project-level targets

When compensation clearly moves with profitability, managers start protecting margins like owners.

Tax treatment:

• Bonuses are generally deductible when paid.
• Taxed as ordinary income to the employee.

An LTIP typically:

• Vests over 3–5 years (or longer)
• Requires continued employment
• May require hitting performance targets
• Pays out at a defined event

For closely held businesses, this is especially useful in leadership transitions or preparing for a future liquidity event.

Important tax note: If structured as deferred compensation, plans must comply with Section 409A rules. Poor documentation or improper payout timing can trigger penalties.

You define a formula:

A percentage of profits goes into a pool. Key employees receive allocations based on role, performance, or structure.

When compensation depends on profitability:

• Expenses get scrutinized.
• Waste gets reduced.
• Pricing discipline improves.
• Operational efficiency increases.

See our guide on 4 keys to incentive compensation success.

Tax considerations:

• Structured as cash bonuses: deductible when paid, taxable when received.
• Structured inside a qualified retirement plan: potentially tax-deferred and deductible (subject to limits).

You agree to defer a portion of compensation today. It grows over time and pays at retirement, separation, or another triggering event. You could make these contributions performance-based too. Learn how deferred compensation can be used to attract and retain senior leaders.

Tax basics:

• Income is typically deferred until received.
• The company usually deducts it when paid.
• Must be carefully structured to comply with tax rules. See how to protect nonqualified deferred compensation arrangements from downside risk.

Before issuing real shares, consider:

• What happens if they leave?
• How is the stock valued?
• Do you have a buy-sell agreement?
• What if you want to sell and they don’t?
• How does this affect family ownership?
• Are you prepared for shareholder disputes?

Equity changes the legal structure of your company. Incentive compensation changes behavior — without changing control.

If you want key employees to think like shareholders, they need:

• Visibility into financial performance
• Clear metrics
• Regular reporting
• Understanding of how enterprise value is built
• A defined long-term strategy
• And most importantly, a clear understanding that as a participant in a performance-based phantom equity program, if operations go well and they meet their performance targets, they will have an opportunity to earn more compensation and build net worth. However, if they fall short of the performance goals, a significant portion of their previously fixed compensation is subject to risk, just like the net worth of the shareholders.

When someone understands how the company makes money — and sees how their personal wealth is tied to improving it — behavior shifts.

Many privately held businesses are structured as an LLC, either taxed as a partnership or as an S Corporation. In either case, there are special considerations that should be addressed in the design of a Phantom Equity and/or other Long-Term Incentive Plan (LTIP). Our ISOP strategy addresses these unique considerations for S-Corporations and LLCs specifically.

In a closely held business, control is valuable. So is alignment.

You don’t have to sacrifice one to get the other.

With thoughtful design, you can drive profitability, increase retention, build enterprise value, prepare for succession, and maintain ownership control.

The right incentive plan allows your key employees to build wealth alongside you — without ever stepping onto the cap table.