What Is Phantom Equity In New Zealand?

If you’re growing a startup or small business, you’ve probably felt the squeeze between two realities:

• You need great people (and you want them to think like owners).
• You can’t always pay “big company” salaries, and you might not want to give away real shares yet.

That’s where phantom equity can come in.

Phantom equity (sometimes called phantom shares) is a way to give key team members a stake in the value they help create, without issuing actual shares or changing your share register. It can be a practical option for New Zealand founders who want to attract and retain talent while keeping control and keeping their shareholding structure straightforward (while noting it can still create real financial obligations and may be relevant to investors and financial reporting).

Below, we’ll break down what phantom equity is, how it works in New Zealand, what to watch out for legally, and the key documents you’ll want in place so you’re protected from day one.

What Is Phantom Equity (And Why Do NZ Businesses Use It)?

Phantom equity is a contractual right to receive a cash payment (or sometimes another type of benefit) that’s calculated as if the holder owned equity in your business.

The word “phantom” is important: the person doesn’t actually become a shareholder. Instead, they get a payout that mirrors the upside of share ownership.

From a business owner’s perspective, phantom equity is often used to:

• Reward and retain senior employees or key contractors by tying reward to long-term value.
• Protect control by not issuing voting shares or diluting founders early.
• Keep ownership administration simpler (particularly before raising capital or selling), while recognising phantom entitlements may still affect deal negotiations and internal financial planning.
• Align incentives so key people focus on growth, profitability, and an eventual exit.

It can also be useful where you want “equity-style” incentives but you’re not ready (or willing) to implement a full employee share ownership plan or issue options.

Phantom Equity vs Real Shares

It helps to be crystal clear on the difference:

• Real shares: the person becomes a shareholder, with rights under the Companies Act 1993 and your constitution (for example voting rights, dividend rights, and information rights depending on share class and documents).
• Phantom equity: the person is not a shareholder; their rights are purely contractual and only exist to the extent set out in your agreement.

This distinction matters because issuing real shares usually means you’ll need to think about governance, decision-making, pre-emptive rights, minority shareholder issues, and what happens if the relationship breaks down. Phantom equity can reduce some of those complexities - but it needs to be structured carefully to avoid disputes later and to ensure the business can fund any payouts when they fall due.

How Does Phantom Equity Work In Practice?

There isn’t one “standard” phantom equity model. The structure depends on what you’re trying to achieve (retention, performance incentives, sale readiness, or all of the above).

That said, most phantom equity arrangements include these building blocks.

1) A Notional Number Of “Phantom Units” Or “Phantom Shares”

You’ll usually allocate a number of notional units (for example 10,000 phantom shares), or a percentage equivalent (for example “the equivalent of 1% of the company”).

Because these aren’t actual shares, you get flexibility on what they mean - but you should define exactly how they translate to a payout.

2) A Vesting Schedule (So The Benefit Is Earned Over Time)

To encourage retention, phantom equity often vests over time (for example, over 3–4 years), and may include:

• A cliff vesting period (e.g. no vesting until 12 months).
• Monthly or quarterly vesting after the cliff.
• Performance hurdles (e.g. revenue targets or EBITDA milestones).

Vesting is one of the biggest “make or break” factors for founder protection. If you don’t set vesting clearly, you can end up owing a meaningful payout to someone who leaves early.

In many businesses, vesting is also dealt with alongside other equity-style incentives, so it’s worth thinking about how a Share Vesting Agreement would operate in your business generally, even if you decide phantom equity is the better option right now.

3) A Payout Trigger (The Event That Creates Value)

Phantom equity usually pays out on a defined event, such as:

• Sale of the business (asset sale or share sale).
• A liquidity event (e.g. significant capital raise, listing, or buy-back scenario).
• Profit-based payouts (e.g. an annual bonus calculated by reference to company value or profit).
• Milestone payouts (e.g. once the company hits a particular valuation).

If your goal is to align your team with an eventual exit, a sale-event trigger is common. If your goal is to build a sustainable, profitable SME (with no immediate sale planned), profit-based phantom equity might be more practical.

4) A Valuation Method (So You Don’t Argue About The Number Later)

Valuation is where phantom equity can get messy if you don’t plan ahead.

Common valuation approaches include:

• Independent valuation (agreed valuer, agreed methodology, and timing).
• Formula valuation (e.g. multiple of EBITDA, revenue multiple, or net asset value).
• Sale price valuation (if a genuine third-party sale happens, use that price).

You’ll also want to define:

• Whether the calculation is based on enterprise value or equity value.
• Whether debt is deducted.
• Whether there’s a “hurdle” amount (e.g. founders receive the first $X of sale proceeds before phantom units participate).

From a founder’s perspective, the goal is to create a valuation process that’s fair but doesn’t allow disputes to derail a transaction (or lead to expensive arguments with a former team member).

Is Phantom Equity The Same As An ESOP Or Share Options?

Not quite - and it’s worth understanding the difference before you choose your incentive structure.

Phantom Equity vs Employee Share Schemes

An employee share scheme (or issuing shares to employees) typically makes the employee an actual shareholder. That can be great for long-term alignment, but it comes with real governance and cap table implications. You may need to update your company’s internal rules, and you’ll want clear documentation around decision-making and exits.

It’s common for growing businesses to tidy this up with a Shareholders Agreement and a Company Constitution, particularly if you’re bringing on investors or giving real equity to team members.

Phantom Equity vs Options

Share options give someone the right to buy shares later (often at a fixed strike price). That means they could become a shareholder in the future, which may still lead to dilution and shareholder management issues down the track.

Phantom equity can be simpler from a company law and shareholder-management perspective: no purchase price, no share issuance - just a right to a payout calculated by reference to growth in value (assuming the trigger happens and the vesting conditions are met). However, it can still be complex in practice because it creates a contractual liability for the business and may have accounting, cashflow, and investor-consent implications depending on how it’s structured.

So Why Choose Phantom Equity?

Founders often choose phantom equity when they want:

• A strong incentive structure without issuing shares;
• More control over how value is calculated and when it’s paid;
• Cleaner governance (no extra shareholders to manage); and
• Flexibility to transition to real equity later if it makes sense.

It can be a “best of both worlds” option - as long as the documentation is properly drafted and the business plans for the financial impact of potential payouts.

What Are The Legal And Tax Issues To Think About In NZ?

Phantom equity sounds straightforward on paper, but it sits at the intersection of employment, contract, tax, and (sometimes) company governance. Getting the details right early can save you a lot of time, stress, and cost later.

1) You’re Creating Contractual Payment Obligations

Phantom equity is ultimately a promise to pay. That means you need to be comfortable with:

• When the payment becomes payable (trigger events, vesting, performance hurdles);
• How it’s calculated (valuation method); and
• Whether you can actually fund it (especially if multiple people participate).

It’s also important to set out whether the payout is subject to board discretion or is automatic once conditions are met. If you want discretion, you need to draft it very carefully - otherwise you risk disputes that you acted unfairly or contrary to the agreement.

2) Employment Law Still Applies (Even If It’s “Equity-Style”)

If phantom equity is offered to employees, you’ll want the incentive to integrate properly with their role and remuneration package. In New Zealand, employment relationships are heavily influenced by good faith obligations, and unclear incentive arrangements can quickly become a source of conflict during performance issues or exits.

It’s common to reference incentives alongside (or within) an Employment Contract, but the phantom equity terms themselves usually deserve a separate, detailed document so the rules are clear and enforceable.

3) Leavers Need To Be Handled Clearly (Good Leaver / Bad Leaver)

One of the most common founder concerns is: “What happens if they resign, or we have to terminate them?”

This is where you’ll typically include leaver provisions, for example:

• Good leaver: resignation with notice, redundancy, illness/injury, or mutual agreement (often keeps some vested entitlement).
• Bad leaver: serious misconduct, breach of restraint/confidentiality, or termination for cause (often forfeits some or all entitlement).

These definitions need to be drafted in a way that’s consistent with NZ employment law and your internal processes. If your definitions are too broad, or if they try to “penalise” an employee unfairly, you can increase the risk of challenge.

4) Tax Treatment Needs Proper Advice

Phantom equity payouts are commonly treated like income (because they’re essentially a bonus), but the tax treatment can vary depending on how it’s structured and who receives it (employee vs contractor, cash vs other benefit, timing, etc.).

Because tax outcomes are heavily fact-dependent, it’s smart to loop in your accountant early and make sure the documents align with the intended treatment. The last thing you want is to promise a “$X net benefit” only for the holder to receive something very different after PAYE or other obligations are applied.

Also, this article is general information only and isn’t tax advice. You should get advice from a qualified tax adviser or accountant on the tax treatment of any proposed phantom equity arrangement.

5) Be Careful With Communications And Expectations

When you roll out phantom equity, the way you describe it matters.

If someone thinks they’re getting “shares” (or shareholder-like rights), but the documents say otherwise, you can end up with misaligned expectations - and disputes at the worst possible time (like during a sale).

Clear drafting and clear onboarding conversations are both part of risk management here.

What Documents Should You Put In Place For Phantom Equity?

If you’re going to use phantom equity, the paperwork is not the place to cut corners. A vague promise in an email or offer letter is a recipe for confusion later.

Most NZ startups and SMEs will need a combination of:

A Phantom Equity Plan Or Policy

This sets the overall framework for your business, such as:

• Who is eligible to participate (roles, seniority, performance requirements);
• The total pool available (e.g. “up to the equivalent of 10% of equity value”);
• How units are allocated and approved;
• Core rules around vesting, triggers, and leavers; and
• How amendments can be made in the future.

If you want a dedicated document designed for this purpose, a Phantom Share Scheme can be a practical starting point because it’s built specifically around “equity-like” incentives without issuing real shares.

Individual Participation Agreements

Even if you have a plan, each participant should typically sign an individual agreement confirming:

• The number of phantom units (or percentage equivalent) allocated to them;
• The vesting schedule and any performance hurdles;
• The trigger events that lead to payout;
• How the payout is calculated (including valuation mechanics);
• Confidentiality around the arrangement; and
• What happens on termination (including good/bad leaver rules).

In practice, many businesses document this through a Phantom Share Agreement that works alongside the person’s employment or contractor terms.

Your Wider Company “House Rules”

Even though phantom equity doesn’t create shareholders, it can still interact with your governance and exit planning. For example:

• If you sell the company, do phantom holders get paid at completion, or later?
• Do you want a board approval process for valuations and triggers?
• Do investors need to consent to your phantom pool?

This is where it helps to have your broader foundations sorted - for example, using a Company Constitution and Shareholders Agreement so your governance is clear as you grow.

Employment And Contractor Documentation

If a phantom equity offer is part of someone’s overall remuneration package, make sure your base terms are also properly documented. This reduces the risk of disputes about what was promised, and when.

For employees, that usually means a tailored Employment Contract, plus clear policies around confidentiality and conduct.

Side Note: Consider How Phantom Equity Fits With “Real” Equity Later

Some businesses start with phantom equity and later transition key people into actual share ownership once the business is more stable (or once investment is secured).

If you think that’s likely, you can design your phantom structure so it can convert (in a controlled way) into real equity or into a vesting model that mirrors real equity concepts. In those cases, it can be useful to think through what a Share Vesting Agreement would look like in the future, even if you’re not ready to implement it today.

Key Takeaways

• Phantom equity gives team members an equity-like upside without issuing real shares, which can help you attract and retain talent while keeping control and avoiding shareholder dilution.
• Most phantom equity arrangements rely on clear rules for vesting, payout triggers (like a sale), and valuation so you don’t end up in disputes later.
• Even though phantom equity isn’t “real equity”, it still creates real legal obligations - particularly under contract and employment principles in New Zealand.
• Leaver scenarios (good leaver vs bad leaver) should be carefully drafted so you’re not unintentionally rewarding early departures or creating unenforceable penalties.
• Tax treatment can vary depending on structure and timing, so it’s smart to get accounting advice early and make sure your legal documents match the intended outcome (and this article isn’t tax advice).
• To protect your business from day one, phantom equity should be documented properly through a clear scheme and individual agreements, and aligned with your wider governance documents.

If you’d like help setting up phantom equity for your startup or SME, we can help you structure it in a way that’s clear, enforceable, and aligned with your growth plans. Reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.