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Public companies can motivate, hire and retain quality employees through the issuance of its publicly traded stock pursuant to various types of incentive programs such as stock option and stock grant plans.
Privately held companies, however, may not be in the position to issue stock to employees but need to provide a means for them to participate in the long-term success of the Company. Offering a shadow equity program can be a good substitute.
Shadow equity is tied to the value of the Company’s stock or some other financial metric but does not involve the actual issuance of stock. Similar to a stock option or grant programs of public companies, vesting periods can be set and the compensation can be delineated in units. The value of the unit can be defined in terms of net income, EBIT, EBITDA, gross margins or some other metric.
Shadow equity is a deferred compensation plan similar to stock option programs but must be funded by the Company directly as the units are not transferable by the employee. Administration of a shadow equity plan, therefore, must be done with careful planning and attention to future payment obligations. Projections of awards should be prepared and accrual of obligations recorded.