Phantom equity is not ESOP.
Your employees think they are on a path to shares. Under a phantom plan, they are not. They hold a right to a cash payment calculated as if they owned shares, and in many plans that payment sits at the board’s discretion. This is a recurring mistake I see across MENA, and its cost is invisible until the exact moment you can least afford it.
What each instrument actually is
A share option is a contractual right to acquire shares in the future: a strike price, a vesting schedule, an exercise window, and shares that enter the register once the option is exercised. Before exercise, the holder is not yet a shareholder. What they hold is the right to become one on defined terms the company cannot quietly rewrite.
Phantom equity is a right to receive money. The payment is calculated as if the employee held shares, but no shares are ever issued and no shareholder rights ever arise. Depending on how the plan is drafted, the board may retain discretion over the terms, the trigger definitions, and sometimes the calculation itself.
The two are routinely handed to employees under the same word: equity. The honest distinction is not ownership versus no ownership, because an unexercised option is not ownership either. The distinction is a right to acquire shares versus a right to receive cash. One can become equity. The other never does.
This is worth being precise about, because phantom equity does not fail because it is phantom. A phantom plan with an objective formula, fixed units, real vesting, a clear change-of-control definition, and limited amendment rights is a legitimate instrument, and some companies choose it deliberately to give economic upside without creating a register full of minority shareholders. Phantom equity fails when it is sold to an employee as ownership and documented as a discretionary payment. The gap between what was said and what was signed is the whole problem.
The jurisdiction problem in the UAE
Which instrument you can issue depends on the structure of the group, not only on where people sit. This is a structural question before it is an HR one, which is why an option plan belongs in the jurisdiction decision, not in an afterthought once the company is already incorporated.
A UAE onshore LLC has no statutory recognition of share options under the Commercial Companies Law. An LLC does not carry the standard share-capital architecture that makes reserving and later issuing shares on exercise administratively clean, the way a Delaware C-corp or an English company does. Founders copy a US or UK option template, sign it, and assume it does what it does at home. It does not, and nobody discovers the gap until someone tries to rely on it.
That is not the whole picture, and the honest version matters. A private joint stock company (PrJSC) does provide a statutory route on the mainland: a capital increase reserved for an employee scheme, under Article 228 of the Commercial Companies Law. It requires a special resolution, it goes to the general assembly, and it explicitly excludes directors from participating, which matters when your senior people are also board members. It is heavier than an LLC, which is why most early companies avoid it. Separately, recent amendments to the Companies Law now allow LLCs to create different classes of membership interest, which opens structuring options that did not exist before. That is an opening, not a solved problem: the law creates the possibility, and its practical use depends on the implementing rules and on how a given competent authority applies them. Treat it as something to explore with counsel, not a plan to copy.
The cleaner answer for most venture-track companies is the free zone. In ADGM and DIFC, employee share schemes are legally recognised under a common-law framework, with proper share classes and enforceable plans. This is one of the genuinely strong reasons to hold the company there. It is not automatic: the plan still needs the right articles, authority to allot, pre-emption handled or disapplied, the correct approvals, an option ledger, and a register updated on exercise. The framework makes a good plan enforceable. It does not make a careless one work.
And note the group point, because it is where cross-border companies get this wrong. The employee can work for a mainland operating company while the award is granted over shares in an ADGM, DIFC, or foreign holding company. The issuer of the option is the holdco, not the employer. Getting that wrong is not a drafting detail. It decides whether the option is enforceable at all.
The problem is exit
When the company sells, the employee learns what “your equity” actually meant: a cash formula, sometimes a discretionary one, under a document they never negotiated.
That conversation happens at the worst possible time. An exit needs the team aligned, retention agreements signed, key people motivated through the transition. Instead, the company discovers that its most important employees feel deceived, and the buyer’s diligence team is reading the plan and pricing the retention risk into the deal.
There can be legal exposure too, where the plan was promised as one thing and documented as another, where the formula is ambiguous, or where terms were changed after rights had vested. But the deeper damage is rarely the lawsuit. It is trust, destroyed at the moment the company needs it most, and priced by a buyer who now treats the team as a risk rather than an asset.
What doing it properly looks like
The UAE levies no personal income tax, so for an employee who is solely UAE tax-resident there is usually no local income tax event to plan around, unlike the UK or US. That is a real advantage, but it is narrower than it sounds: employees who are tax-resident elsewhere, who relocate between grant and exit, or who carry obligations by citizenship can still face foreign tax, and the company still has its own accounting and corporate-tax treatment to handle. If the company sits in ADGM or DIFC, there is little excuse not to run a real plan rather than default to phantom.
The mechanics that matter: reserve the pool early, typically 10 to 15% of fully diluted shares, before Series A, because investors will require it. Set a defensible strike price. Keep options in an option ledger, not in the register of members, which they only enter on exercise. And define the terms that actually decide the outcome at a sale: vesting, cliff, exercise window, leaver treatment, and what happens on a change of control. Those clauses, not the headline percentage, determine whether the plan holds up when the company is sold.
One point founders miss: the pool sizing is itself a negotiation. An investor asking for a 15% pre-money pool is asking existing holders to absorb that dilution before the round is priced, rather than sharing it with the new money. That mechanic, and how it compounds across rounds, is where the real cost of a pool sits, long before any employee exercises anything.
Phantom equity is not the villain. A phantom plan honestly labelled and cleanly drafted is a legitimate choice. The failure is the shortcut version: ownership language over a discretionary payment, signed fast, never modelled to exit. Like every structural shortcut, it does not remove the cost. It moves the cost to exit, multiplies it, and hands the bill to the moment when your leverage is lowest.