Comparative Analysis: Phantom Stocks vs. ESOP vs. Sweat Equity Shares

These plans are popular among startups and mid-sized companies looking for alternative compensation strategies to attract and retain top talent without immediate cash outlays or equity dilution. 


Phantom Stock Plan (PSP)

Employee Stock Option Plan (ESOP)

Sweat Equity Shares


PSP  also known as shadow stock is an equity incentive plan in which employees are offered cash payment based on the performance of the company’s shares without actually granting ownership of such shares.  

These are employee benefit plans that give employees an opportunity to acquire ownership interest in the company by purchasing the shares of the company at a pre-determined price which is usually lesser than the market price of the company.

Sweat equity shares are shares given to employees or directors in lieu of their contribution to the company in the form of intellectual property rights or know how or any other value additions.


Employees receive cash payment to the extent of thevalue of the company’s stock or its appreciation over a certain period.

Employees receive Options that can be converted into shares of the company at a later date at a pre-determined price which is usually lower than the market price.

Shares are issued to employees at a discounted price for the value of their contributions (time, effort, expertise, and value addition).


·         No dilution of company’s equity capital

·   Aligns employee interests with that of the   company and improve employee performance

·      Easy to manage and implement than issuance  of shares

·       No reporting/ compliance requirements under  the Companies Act

·         Alignment of interest of employees with that of the company;

·         Rewards employees for their performance;


·         Preserves company cash flow

·   Attracts talent who believe in the company’s future potential

·       Promote stronger alignment with the company’s objectives


·         No actual ownership in the company


· Potentially significant cash outflows for the company.

·         Dilution of ownership for existing shareholders;

·         ESOP policy may me complex to set up and manage

·         Company loses potential funds that could have been raised by issue of same securities to other investors.

·         Dilution of ownership for existing shareholders.

· Difficult to value non-cash contributions accurately.

·     Potential for disagreements over the valuation of contributions.

Ideal use cases

·    Suited for matured companies looking to reward employees without diluting ownership

·   Companies with cash reserves to handle payouts.

·      Ideally suited when company is looking to retain and motivate employees;

·      Companies considering succession planning or corporate restructuring.

·         Early-stage startups with limited cash reserves.

·      Companies seeking to attract and retain highly motivated employees.

Ownership and Dilution

No actual ownership, no dilution

Ownership transferred to employees, significant dilution.

Direct ownership transfer, dilution dependent on share issuance. 

Financial Impact on Company

Deferred cash outflow, no equity impact.

Immediate equity impact, potential tax benefits

Immediate dilution, preserves cash flow.

 *Companies considering incentivizing the management/ top executives who are not eligible for ESOP may do so by way of sweat equity shares or partly paid-up shares.

Author: Burhanuddin and Manasa, Associates, NovoJuris Legal


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