Alternatives to options: phantom stock, SARs, RSUs

1. The core idea#

Stock options are the default equity tool for a startup, and for most early employees they remain the right one (5.02). But options have limits. Some people you want to reward cannot legally receive them. Some cannot afford to exercise them. Some will never benefit from them because the company's value is already high. For those cases there are three main alternatives:

• Phantom stock: a contractual promise to pay cash equal to the value of a number of notional shares (or the increase in their value) when a defined event happens, usually an exit. No shares are ever issued.
• Stock appreciation rights (SARs): a right to the increase in value of a number of shares above a base price. Settled in cash or in shares. Close to an option with no exercise price to pay.
• Restricted stock units (RSUs): a promise to deliver actual shares (or their cash value) once vesting conditions are met. The employee pays nothing; the whole value of the share is the reward.

Who this is for: a founder who has an equity plan (5.02) and has hit one of these situations:

• you want to reward an overseas consultant, advisor or contractor who is not eligible for your Indian ESOP plan;
• you have a late-stage hire for whom options at today's strike price are worth little;
• you have employees in a country where options are taxed badly or are hard to administer (5.18);
• your investors have capped dilution and the pool is full (5.03), so you want a cashlinked incentive instead.

The principle: use an alternative only to solve a specific problem that options cannot. Every alternative swaps one cost for another. Phantom stock and cash SARs avoid dilution but create a cash liability and, usually, a higher tax bill for the employee. RSUs avoid the exercise price but create a tax bill at a time when the employee may have nothing to sell. Related: 5.02 (ESOP plan design), 5.03 (pool top-ups), 5.08 (ESOP tax), 5.09 (exercise windows), 5.18 (equity for employees in other countries), 4.11 (advisor agreements).

2. How each instrument works (November 2026)#

Side by side#

The accounting row matters more than founders expect. Under Ind AS 102 and US GAAP (ASC 718), cash-settled awards are liabilities whose value is re-measured at each reporting date. As your valuation rises, the expense in your accounts rises with it, and your auditors will ask for a valuation each year.

Tax for the holder: India#

• Phantom stock and cash-settled SARs: the cash payout is taxed as salary income in the year of payment, at slab rates, with TDS deducted by the employer. There is no capital gains treatment, because no shares change hands. For a large payout at the top slab under the new regime the effective rate is roughly 30–39% after surcharge and cess, depending on the amount.
• Share-settled SARs and RSUs: taxed like ESOPs. The value of the shares received is a perquisite when they are allotted; later growth is a capital gain when the shares are sold. The perquisite-tax deferral for eligible DPIIT-recognised startups (5.08) can apply to shares allotted under these schemes, but not to cash payments.
• The comparison with options: with an option exercised early, most of the gain can end up as long-term capital gain (12.5% on unlisted shares held for more than 24 months under current rules). With phantom stock, the whole gain is salary. For a large exit, that gap can be 20 percentage points or more.

Tax for the holder: United States#

• Phantom stock and SARs are deferred compensation and must comply with Section 409A, or be designed to fall within an exemption. A SAR on common stock with a base price at least equal to fair market value on the grant date (5.07) can be exempt; a phantom plan usually needs fixed payment events such as a change of control. Failing 409A means tax on vesting plus a 20% federal additional tax and interest.
• Payouts are ordinary income, subject to income tax withholding and FICA.
• Private-company RSUs are almost always double-trigger: they vest on time plus a liquidity event (IPO or acquisition), so the employee is not taxed on shares they cannot sell. To stay within 409A, they usually expire if no liquidity event happens within about seven years of grant, and 409A generally prevents extending that term.
• When an IPO triggers all double-trigger RSUs at once, holders face a large ordinaryincome tax bill in a single year.

Tax for the holder: United Kingdom#

• Phantom stock and cash SARs are employment income, taxed through PAYE with employee and employer National Insurance (employer NIC 15%). They are much less tax-efficient than an EMI option, which can turn most of the gain into a capital gain (5.02, 5.18).
• Growth shares (a separate class of shares that only participates above a hurdle) are a common UK alternative for people who cannot get EMI.

India: the law is catching up#

Unlisted Indian companies have so far operated RSUs and SARs inside the ESOP framework of the Companies Act and the 2014 Share Capital Rules, because the Act only expressly recognised ESOPs and sweat equity. The Corporate Laws (Amendment) Bill, 2026, introduced in the Lok Sabha on 23 March 2026, would amend Section 62(1)(b) to cover share-based schemes linked to the value of share capital, bringing RSUs and SARs expressly within company law, as the SEBI SBEB Regulations already do for listed companies. A Joint Parliamentary Committee reported on it on 3 August 2026. Check whether it has been passed and the revised rules notified before relying on it. Commentators note that it does not change the income-tax treatment.

3. How to do it: choosing an instrument#

Step 1. Start from the problem, not the instrument

Step 2. Decide what the award pays for#

• Growth only (SAR-like): pays the increase above today's value. Matches an option's economics. Use for incentive.
• Full value (RSU-like): pays the whole value of the notional shares. Worth more per unit, so grant fewer units. Use for retention when today's value is already high.

Step 3. Fix the payment events in writing#

For phantom stock and cash SARs, write down exactly when payment happens: a change of control, an IPO, a secondary or buyback programme (5.10), and possibly a fixed date. Vague triggers ("at the board's discretion") create disputes and, in the US, 409A problems. State how value is measured: the price per share in the exit, or a valuation by a registered valuer (India) or a 409A provider (US) for non-exit events.

Step 4. Cap the cash exposure#

Model the payout at three exit values (5.19). Write a cap into the plan, for example a maximum total payout as a percentage of exit proceeds, so that the phantom plan behaves like a slice of the pool rather than an open-ended debt. In practice, acquirers treat phantom payouts as a transaction expense, which reduces what shareholders receive, much as options do.

Step 5. Count it against the pool#

Even though phantom units create no shares, count them as if they were options when you report fully diluted ownership to investors. Investors will do this anyway, and hiding them damages trust.

Step 6. Plan the accounting#

Tell your auditor before you grant. Cash-settled awards must be re-valued each year as a liability. Budget for the valuation and for a rising expense line as your valuation grows.

Worked example#

An Indian materials startup (Private Limited, DPIIT-recognised) wants to reward a German professor who consults two days a month and is not an employee. Its last valuation implies ₹ 100 per share. The founder considers 10,000 options, which are not available because the professor is not an employee, and settles on 10,000 phantom units that pay the growth above ₹ 100 on an exit, vesting monthly over two years.

The company caps total phantom payouts across all holders at 1% of exit proceeds and counts the 10,000 units in its fully diluted table.

Tax comparison for the holder (illustrative). The professor is taxed in Germany as a German resident; the Indian company may also need to consider Indian withholding on payments to a non-resident for services, subject to the India–Germany tax treaty. If the same award had been given to an Indian employee as options exercised early, most of the ₹90 lakh gain could have been long-term capital gain at 12.5%. As phantom stock, the whole ₹90 lakh is salary, taxed at roughly 34% at the top of the new regime (30% slab, 10% surcharge, 4% cess). That is a difference of roughly ₹17–20 lakh (depending on surcharge) in tax on the same gain.

What the founder learns: phantom stock is the right tool for the consultant, because nothing else is available. It is the wrong tool for employees who could hold options, because it costs them heavily in tax.

4. Country notes#

India#

• Who can get ESOPs. Under the Companies Act and the Share Capital Rules, ESOPs in an unlisted company can go to permanent employees and to directors (not independent directors), including employees of a holding or subsidiary company. Consultants and advisors are not eligible. Promoters and holders of more than 10% are excluded, except that eligible startups may grant ESOPs to promoters for a period after incorporation (see 5.02). Anyone outside these groups needs a contractual instrument such as phantom stock.
• Phantom stock today is a contract approved by the board, not a Companies Act scheme. Write a proper plan document with vesting, payment events, valuation method, leaver terms and a cap. Valuers typically use the same method as for ESOP perquisites (Rule 11UA-style valuation by a merchant banker) so the numbers survive tax scrutiny.
• RSUs and SARs settled in shares are run under the ESOP framework until company law changes. That means shareholder special resolution, the one-year minimum vesting rule and the usual filings (5.02, 5.06).
• The 2026 Bill. The Corporate Laws (Amendment) Bill, 2026 would expressly recognise share-value-linked schemes such as RSUs and SARs under Section 62(1)(b), and bring them within buyback restrictions in Section 68. Until it is passed and the rules are revised, structure everything under the existing ESOP rules.
• Payments to people abroad. A cash payout to a non-resident consultant is a currentaccount remittance for services. Check withholding tax and the relevant tax treaty, and get the bank's documentation requirements in advance (4.19).
• Tax withholding. Cash payouts to employees are salary: deduct TDS in the month of payment. Make sure the plan lets you withhold.

United States#

• Section 409A governs phantom stock, SARs and RSUs. Design SARs with a base price at or above fair market value on the grant date (supported by a 409A valuation, 5.07); design phantom and RSU payments around fixed events (change of control, IPO, a fixed date). Have counsel review the plan; 409A failures fall on the employee.
• Securities law. Share-settled RSUs and SARs are offers of securities; private companies usually rely on Rule 701 and state exemptions, as for options. Purely cashsettled phantom plans generally do not involve securities, but check state rules.
• ERISA risk. A broad phantom plan that pays at or after retirement can look like a pension plan. Plans that pay on an exit or a fixed date and cover a limited group are usually structured as bonus arrangements to avoid this; ask counsel.
• ISOs are better where available. For US employees, ISOs or NSOs usually beat phantom stock on tax (5.08). Use alternatives mainly for non-employees and latestage hires.

United Kingdom#

• EMI first. An Enterprise Management Incentive option is far more tax-efficient than any cash-settled award for a qualifying employee of a qualifying company. Check the current EMI limits (raised in 2026) before choosing anything else (5.02, 5.18).
• For people who cannot get EMI: consider a Company Share Option Plan (CSOP), growth shares, or unapproved options before phantom stock.
• Phantom stock and cash SARs are taxed as employment income through PAYE, with employee and employer National Insurance. The employer's 15% NIC adds to the company's cost at payout.

Employees in other countries#

Some countries tax options at grant or vesting, or require a local prospectus or filing for share offers. In these places a cash-settled phantom award can be simpler. In others, local tax-favoured plans exist. See 5.18 before granting anything to a person outside India, the US or the UK.

5. Scripts, mistakes and sources#

Scripts#

Offering phantom units to a consultant

"Because you're not an employee, our ESOP plan can't include you. Instead we'll give you 10,000 phantom units. They work like options with no exercise price: if we're acquired or go public, you get paid the increase in value above ₹100 a share, in cash, for every unit that has vested. The payout is taxed as income, not as a capital gain, so I'd suggest you check the tax position where you live."

Explaining double-trigger RSUs to a late-stage hire

"Your RSUs vest over four years, but you don't receive the shares, or pay tax on them, until there's an IPO or an acquisition. If neither happens within seven years of the grant, the unsettled units lapse. That's a tax rule, not our choice, and we'll explain what we would do if we get close to it."

Telling an investor about a phantom plan

"We have 25,000 phantom units outstanding for two overseas consultants. They create no shares, but we show them in the fully diluted table as if they were options, and total payouts are capped at 1% of exit proceeds."

Common mistakes#

1. Using phantom stock for employees who could hold options. It usually costs them a lot more in tax and costs the company cash.
2. Vague payment triggers. "At the board's discretion" invites disputes and, in the US, 409A problems.
3. No cap on the cash liability. An uncapped phantom plan is an open-ended debt to employees at exit.
4. Leaving phantom units out of the fully diluted table. Investors will find them in diligence.
5. Ignoring the accounting. Cash-settled awards are re-measured every year. A rising valuation means a rising expense line and an audit question.
6. Single-trigger RSUs in a private company. The employee owes tax at vesting on shares they cannot sell.
7. Assuming the 2026 Indian Bill is law. Until it is passed and the rules updated, run RSUs and SARs under the existing ESOP rules.

Related playbooks#

• 5.02 ESOP plan design: India (Companies Act rules) vs US (ISOs and NSOs)
• 5.03 Pool top-ups and who absorbs the dilution
• 5.06 Vesting schedules, cliffs and back-loaded vesting
• 5.07 Setting the strike price: US 409A and Indian valuations by a merchant banker
• 5.08 ESOP tax: Indian perquisite tax and the DPIIT deferral; US ISO and AMT
• 5.10 ESOP buybacks and liquidity programmes
• 5.17 Bonuses, commissions and sales compensation plans
• 5.18 Equity for employees in other countries
• 5.19 Modelling the cap table across rounds
• 4.11 Advisor agreements (FAST template); 4.19 FEMA, FDI and ODI rules

Sources#

• Bar & Bench, Beyond ESOPs: how the Corporate Laws (Amendment) Bill 2026 reshapes India's equity compensation landscape (May 2026); TaxGuru, Promoter phantom stock after the Corporate Laws (Amendment) Bill, 2026 (2026)
• Fox Mandal and Tribune/ANI on the Joint Parliamentary Committee report (3 August 2026); PRS Legislative Research bill page
• King Stubb & Kasiva, Phantom stock and stock appreciation rights in India (August 2026); Treelife, Phantom stocks in India: 2026 guide IncorpX, ESOPs vs RSUs vs SARs (2026)
• Carta, Restricted stock units: how they work, benefits and taxes (August 2026) NASPP, Private company liquidity events explained (April 2026); Baker McKenzie, Double-trigger RSUs and the question of the seven-year term
• Joe Wallin, Startup equity compensation guide (The Startup Law Blog, August 2026)

This playbook is general information, not legal, tax or accounting advice. Phantom and SAR plans need a properly drafted plan document; take advice in each country where a holder lives.