What Does Not Work: Options, Phantom Shares & Stripped Shares

Giving an option instead of shares

This is a proposal that comes up often, and in its usual form it scores nothing at all. The idea is attractive: give your black partner an option to buy shares at some point in the future, record 51% black ownership now, and keep control in the meantime. An option is simply a right to buy something later at a price agreed now. The Codes deal with this expressly, and the answer is no.

Paragraph 3.13 of Statement 100 does allow votes and economic interest to be recognised before an option is exercised — but only where all of a demanding set of conditions are met (paragraphs 3.13.1 to 3.13.4). In plain terms, all three of these have to be true:

• the votes attaching to the shares are irrevocably transferred to the option holder for the option period, and can be exercised by them before they acquire the shares;
• the value of the economic interest is irrevocably transferred to them for the option period and actually paid to them before the option is exercised; and
• the value of the instrument is determined using a standard valuation method for calculating net value.

That is our plain-English summary of the paragraphs, not the words of the Codes — you can read Statement 100 for yourself in the sources.

Read those again, because they undo the reason for using an option. A person proposing an option normally wants to keep the votes, keep the dividends, and keep the ability to walk away. The Codes require the first two to be given away irrevocably — and requiring irrevocability largely removes the third. Having given all that up, you have conceded almost everything you would have conceded by simply transferring the shares, but with a worse scorecard result.

Even a “compliant” option is not a safe bet on net value

Suppose the option is genuinely structured to meet all of paragraph 3.13’s conditions. It is still likely to struggle on net value, but the analysis is not automatic. The Codes require the value of the instrument to be determined using a standard valuation method for calculating net value. Whether the exercise price is also “acquisition debt” — debt taken on to buy the shares, which reduces net value until it is paid down — depends on whether the holder has actually incurred a debt or financial obligation to acquire the equity interest. It does not follow merely from the fact that a price is payable on exercise.

So the two questions to put to your adviser are: what is the instrument worth on a standard valuation, and has the holder incurred an acquisition debt as the Codes define it? Do not accept a general assurance that an option “solves” net value.

Phantom shares and profit shares

A phantom share scheme gives someone a cash payment calculated by reference to what a share is worth. A profit share gives them a percentage of profits. In each case the payment tracks the business — but no share is ever issued or transferred. That single fact is why neither counts as black ownership.

Walk it down the three ownership measures and each one lands on zero:

• Voting rights — nothing. The participant holds no share, so they have no vote at shareholders’ meetings. The voting lines on the scorecard score nothing.
• Economic interest — nothing. What they hold is a contractual claim calculated by reference to share value — a debt the company owes them, ranking ahead of shareholders rather than behind them. That is not “a return on ownership” as economic interest is defined, so it scores nothing.
• Net value — nothing. There is no equity instrument to value, so net value scores nothing.

None of that makes these schemes bad. They are perfectly good tools for retaining and motivating staff — a way to let key people share in the upside without diluting the shareholders. They are simply not ownership.

Shares with the rights stripped out

The general point behind the two structures above is worth stating on its own, because it explains most failed structures. The scorecard measures votes, money and real ownership separately, and you cannot score by giving away the label without the substance.

• A share that carries no vote does not earn the voting points.
• A share that carries no dividend right does not earn the economic-interest points.
• A share bought entirely with debt that never reduces does not earn the net-value points.

Put plainly: there is no structure that costs you nothing and scores well, because the scorecard was designed to measure exactly what it costs you. Each measure is testing for a different piece of real ownership — a genuine vote, real money flowing to a real owner, and real value building up in that owner’s hands. Strip any one of those out and the corresponding points go with it.

This is also the honest way to sanity-check any clever-sounding proposal. If a structure promises the score without the cost — control retained, cash retained, value retained — something has been stripped out, and the points will not follow. The scorecard is not looking at the name on the instrument; it is looking at who really votes, who really gets the money, and who really owns the value. A structure that fails all three while calling itself black ownership is not just a weak scorecard result — dressed up as the real thing, it edges toward fronting.

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