What is a virtual stock option plan (VSOP)?

Many companies offer employees stock options (essentially partial ownership of the company) as part of their compensation package. However, many startups offer virtual stock options as an alternative.

A virtual stock option plan (VSOP) guarantees that an employee will receive a cash payout at a designated time or when a specific event occurs in the future. The payment amount depends on how much virtual stock the employee owns and the value of the stock at the time of payment—some virtual shares are worth only a portion of a traditional share. 

In a VSOP, the employee is not an actual shareholder and doesn’t have any of the rights or privileges as such. Their “ownership” in the company is on paper only, and virtual stock owners do not participate in shareholder meetings, have the right to vote on shareholder issues, or receive dividends. Every company determines the program conditions, who qualifies for virtual stock options (VSOs), and how many. Some of the factors that influence share offerings include:

• Job role
• Job category
• Seniority 

Why do companies offer virtual stock option plans?

A virtual stock option program aligns the company’s and the employees’ interests by creating an incentive to reach performance targets and increase stock value. Because the value of the cash payout is tied to the stock performance (and thus increases or decreases with the stock value), employees in the program have reason to become more engaged stakeholders in the company’s performance. 

Although employees are the most common participants in virtual stock programs, some companies extend the option to third-party vendors, investors, directors, and others. This is most common in startups.

What do employees need to know about virtual stock option plans? 

In most cases, employees have to meet specific requirements to collect the payment from the virtual stock program. The most common requirement is that the employee is vested, meaning that they’ve worked with the company for a specific period of time. Few programs immediately vest employees in the virtual (also known as phantom or ghost) stock program. Some companies also tie this compensation to performance targets. This means that employees have to meet defined goals to qualify for payment. 

The period when employees can’t collect their virtual stock options is known as the cliff. During this period, if the employee leaves the company for any reason, they forfeit their VSOs. Once vested, depending on program policy, employees may receive their allotment of VSOs or a portion, with more added annually, until they reach the cap.

There are tax implications to participating in a virtual stock option plan. Although the initial grant of virtual stock is not subject to taxation, the payout is taxed as regular income. In some cases, the value of the stock is taxed when the employee becomes vested if the virtual stock is tied to the value of the actual stock. Usually, these stocks do not earn dividends, but the standard tax code applies if they do.

What do employers need to know about virtual stock option plans?

VSOPs are treated as deferred compensation. The amount changes every year, and the liability needs to be recorded as the value goes up or down. A VSOP can cause a company’s balance sheet to appear more imbalanced. Because the options have to be recorded as deferred compensation, it can cause the company to appear over-indebted on a balance sheet. Although carrying what looks like excess debt reflects negatively on the books, the reality is usually not nearly so dire. 

Companies need to have provisions for when vested employees make a claim.

Clear and detailed record-keeping is critical to a successful VSOP. Startups looking for investors or considering a sale need accurate records of who has virtual shares, how many, and the promised payments to avoid the uncertainty that could drive away potential investors, partners, or buyers.

Disclaimer: This article and all information in it is provided for general informational purposes only. It does not, and is not intended to, constitute legal or tax advice. You should consult with a qualified legal or tax professional for advice regarding any legal or tax matter and prior to acting (or refraining from acting) on the basis of any information provided on this website.