We interviewed Richard Chen, a seasoned corporate and securities attorney with more than 25 years of practice under his belt, following his graduation from Harvard College and Harvard Law School. He is the Founder and President of Brightstar Law Group, a law firm specializing in serving the regulatory and corporate needs of investment advisory firms.

How should RIA’s or independent practices be thinking differently  about “annual practice growth bonuses” vs. “phantom equity”  vs. “real equity” to retain top talent?

RC: The cleanest way to think about these three tools is that they solve different problems. They are not really substitutes for one another. They sit on a ladder depending on the goals of the firm.

An annual practice growth bonus is usually the best tool when a firm wants to reward near-term performance, whether for the individual or the firm as a whole. It is simple, cash-based, and easy for employees to understand. However, it usually drives short-term behavior as opposed to longer-term behavior and retention.

Phantom equity is usually the middle-ground tool. It is often the best fit when a firm wants senior employees to think like owners and stay for the long term, but the owners are not yet ready to give actual equity, voting rights, or access to governance. It lets the firm tie part of compensation to the growth in enterprise value without immediately changing the cap table.

Real equity is usually the right answer when the person is genuinely part of the firm’s long-term ownership and succession plan. If the employee is expected to help run the firm, participate in major decisions, and potentially become part of the next generation of owners, real equity is often more credible and more motivating than synthetic economics alone.

What protections are common for either party when it comes to structuring phantom equity?  For example, are employees concerned that since they don’t have voting rights or TRUE equity, that the true equity owners can change the deal?

RC: Some sophisticated employees do think about the fact they are not getting governance and information rights with phantom equity but in reality they would not really get much in the way of governance rights even if they get real equity. Phantom equity is only as good as the contract that creates it. Because the employee does not usually have voting rights, statutory minority protections, or direct access to the economics of actual ownership, the written plan terms matter.

From the employee’s perspective, the most important protections are usually these: a clear written award agreement, a defined valuation methodology, objective vesting rules, clear payout timing, protection against adverse amendment of already-granted awards, and sensible treatment on a sale of the firm, retirement, death, disability, or termination without cause.

Employees are often especially focused on whether the owners can rewrite the plan after the award is granted. Market practice generally favors a distinction between future plan amendments and already-issued awards. Owners may reserve the right to amend the plan going forward, but employees often seek language that prevents the firm from materially impairing an existing award without the holder’s consent.

Valuation is another major issue. If the plan says the owners can determine value in their sole discretion, the employee may reasonably view the award as less meaningful. A stronger structure usually provides for an agreed formula, an internal valuation method applied consistently, or a third-party appraisal standard.

From the employer’s perspective, the common protections run the other way. Owners usually want vesting tied to continued service, clear forfeiture rules for misconduct, flexibility to pay over time rather than in a lump sum, and drafting that avoids accidental creation of governance rights. They are also focused on tax compliance, especially Section 409A, because phantom equity often functions as deferred compensation.

The practical answer is that phantom equity can work very well, but only if the bargain is clearly defined. Because the employee does not have true ownership rights, the contract has to clearly spell out the bargain.

Can you share an example of a RIA’s phantom equity plan?   What was the ballpark firm size in AUM and headcount?  How was the phantom equity structured?  What were the positions that were granted and tenure of the employee(s)?  How many partners/owners had TRUE EQUITY?

RC: We generally don’t share those details but typically they are appropriate for firms with somewhere north of $500MM in AUM and employees who are meaningful to the firm but where either the employees have more to prove or the owners are not ready to share full equity.

From your perspective, do you feel that it will become more common for a high level employee, that is new to the firm, be granted phantom equity from the start?  (As an attraction tool?...We don’t see it often on our side).   If you were an employee (non advisor) looking for a new firm, how would you go about addressing phantom equity as part of the compensation package?

RC: Yes, I do think it will become more common, especially for truly strategic hires. But I would not say it is becoming standard in the sense of being automatic for every new senior employee. It is more likely to be used selectively.

The most likely candidates for an early phantom-equity grant are senior hires who are expected to move the value of the business in a measurable way. That could be a chief operating officer, a head of growth, a highly strategic service-line leader, or a senior advisor who brings real business-development strength. For those hires, phantom equity can be a useful recruiting tool when the firm is not ready to offer true equity immediately.

For a non-advisor employee negotiating a package, I would not treat phantom equity as a symbolic perk. I would treat it as a valuable right and ask practical questions. Is the award full-value or appreciation-only? How is the firm valued? Who controls that valuation? What happens if the firm is sold? What happens if I am terminated without cause? Can the firm amend the award after grant? When do I actually get paid?

I would also want to know whether phantom equity is intended to be the end state or a bridge to real equity if the relationship works. In many cases, the most attractive arrangement for a senior employee is not phantom equity by itself, but phantom equity plus a credible path to real ownership later.

So my practical view is that day-one phantom equity will probably become more common at the high end of the market for important hires, but it is still likely to remain a selective tool rather than a default feature of compensation packages.

Anything else you’d want to share to either practice owners or wealth management employees on the vast topic of firm equity?

RC: In short, I think RIA talent wars make this a valuable tool for firms who are wanting to incentivize longer-term behavior but who are not yet ready to grant full equity. However, they have to be carefully thought out because these plans create contractual obligations RIAs have to be comfortable living with.