Phantom Stock

John Lucey faced a challenge that's a perennial quandary among owners of family businesses and other closely heldcompanies: How to compensate fairly and motivate essential nonfamily managers without granting them equity. "I have onekey employee who brings a lot of value to the company," says Lucey, president of Wakefield Distribution Systems, awarehousing, transportation, and moving company based in Danvers, Mass. "I wanted to give her a long-term incentive tostay with us."

Lucey's solution was a "mirror" or "phantom" stock plan that his lawyer helped him devise and which was implemented in1994. This compensation tool is designed to motivate and retain key employees without sharing ownership in the company.Such plans can yield some of the same payoffs as equity grants or stock options. Using phantom stock "it's possible to pass onthe same financial reward to executives or others without incurring any of the risks or complications that might accompanythe sharing of equity," notes Jim Scannella, a principal in Arthur Andersen's human capital services group.

Here's how phantom stock plans work: You give your executive 1,000 shares of so-called phantom stock at, say, $10 a share.The phantom stock is not actual equity but is tied to the value of your company's stock. You schedule a company valuation forsome future date -- or spell out a formula that will determine the stock's value. If the valuation or the valuation formula showsthat your company's stock has risen by, say, $30 a share, you send the executive a $30,000 check. At tax time, your companyqualifies for a $30,000 tax deduction, while your executive pays taxes on $30,000 worth of ordinary income.

Each year for 10 years at Wakefield Distribution Systems, senior vice president Gabrielle Fecteau, the employee whomLucey considers essential to his business, earns "stock" equal to 1% of the company's assessed value. At the end of that time,she may cash out over a 10-year period, collecting not more than 10% of her accumulated value each year. And ifLucey -- who owns the majority of the stock and whose children own the rest -- at some point declares a dividend, Fecteau isentitled to a percentage equivalent to the amount of "stock" she has earned up to that point. Wakefield's accounting firm doesan annual business valuation. Over the course of five years, Lucey says the value of the company -- which had 1998 revenuesof $18 million -- has almost doubled.

Fecteau's continued presence is critical to Lucey's succession plan. His three children, ages 31, 30, and 25, are all involvedin the business. "My son, Kevin, is managing a division of the company," says Lucey, "and I want to give him some time tomature and to learn the business from Gaby as well as from me. She has more time to teach and train than I do, plus, my songets a different perspective from her." Lucey expects to be actively involved in the business for another three to five yearsand hopes that after that, his son and Fecteau will run it together. In the meantime, Lucey is quite pleased with his phantomstock ? or, as he prefers to call it, mirror stock ? plan. "It's the best way to incentivize key employees in a family-ownedbusiness or small business," he says.

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