Attracting and retaining high-quality employees is becoming increasingly difficult for many companies. Despite relatively low unemployment, the labor market remains tight, labor costs are rising, and employees’ expectations of receiving not only short-term but also long-term financial benefits from their work are growing. It is precisely in this context that various forms of employee stock ownership are becoming increasingly prominent – ranging from employee stock and option programs to so-called virtual shares.
While employee stock and option programs have long been standard practice abroad, their development in the Czech environment has for years been hampered by legal and tax uncertainty stemming from insufficient or entirely absent legislation. However, this has changed significantly in recent years. Czech legislation has gradually responded to practical needs and opened up new possibilities for involving employees in the growth of company value in a meaningful and predictable way.
In this article, we therefore first summarize why the topic of employee participation is more relevant today than ever before and what legislative changes have influenced it. We will then introduce and compare the three most common models of employee participation in a company, which can also be applied to Czech companies – employee stock option plan, direct sale of shares or interests to employees, and phantom shares. Finally, we will briefly focus on which of these models makes practical sense for which employer and under what circumstances.
Options for employee participation in the company
In recent years, legal and tax regulations in the Czech Republic have undergone significant changes, affecting the ways in which employees and other key individuals can participate in the company’s value. Until then, the practice of employee stock and option programs was often complicated precisely because of unclear tax rules and a high tax burden upon the acquisition of shares.
Gradual but still very cautious legislative changes in recent years have sought to remedy this situation, the most significant of which is the introduction of a new framework for employee stock option plan from 1 January 2026, which you can read about in detail in our previous article here. However, utilizing this framework is by no means the best or only option for all employers. In practice, alternative models of employee participation continue to exist, such as the direct sale of shares or interests or phantom shares. Each model addresses a different type of corporate need and business direction and has significantly different legal and tax implications that must be taken into account when selecting an appropriate solution.
ESOP – Employee Stock Option Plan
Employee Stock Option Plan (hereinafter as the “ESOP”) allows employees to participate in the future value of the company without immediately becoming its partners or shareholders. The basic principle of ESOP is the granting of an option, i.e., the employee’s right to acquire shares or an interest in the company in the future under predetermined conditions or at a predetermined price.
ESOP is typically structured as a long-term incentive tool. An employee acquires options gradually, usually through a process known as vesting. Vesting typically takes place over several years and is often supplemented by a “cliff”, i.e., a minimum period during which the employee must remain with the company to become eligible for at least a portion of the options.
After fulfilling the vesting conditions, the employee has the opportunity to exercise the option, i.e., actually acquire shares or an interest in the company. However, even at this point, no financial payment may occur, especially in the case of a company whose shares are not publicly traded. The economic effect of ESOP therefore usually manifests itself in practice only upon a liquidity event, typically the sale of the company or a part thereof, or upon the entry of an investor who enables the buyback of employee shares, ideally at a higher sale price than the price at which the employee purchased the shares upon exercising the option.
The previous legal framework governing ESOP in the Czech Republic was problematic, particularly from a tax perspective. The obligation to pay tax could arise as early as the moment the option was granted – that is, at a time when the employee had no means of cashing in the shares.
Qualified employee stock options, which employers can now utilize under ESOP plans, constitute a special tax regime that applies only if the conditions set forth by law are met.[1] If these conditions are met, the employee incurs no tax liability upon the grant of the option, upon vesting, or upon the acquisition of the share. Income tax applies only at the moment the employee realizes an actual economic benefit, i.e., upon the sale of the share or upon another triggering event specified by law. It is also crucial for all parties involved that no social security or health insurance contributions are deducted from such income.
From a legal perspective, a qualified ESOP is neither a new type of security nor a special form of company share. It is a combination of standard private law instruments – option agreements and related corporate documents – supplemented by a specific tax regime. A well-structured ESOP therefore typically includes an option plan approved by the relevant (usually the highest) corporate body, individual option agreements with employees, and corresponding amendments to the articles of association, statutes, or shareholder agreements. The documentation also typically includes rules for various scenarios involving the termination of an employee’s employment, restrictions on the transferability of shares, and the conditions under which an employee may exercise an option.
The qualified ESOP regime is limited exclusively to employees in an employment relationship and cannot be applied to persons cooperating with the company on the basis of another legal title, such as external contractors or consultants.
Virtual programs – phantom shares
ESOP represents a significant expansion of employee participation options, but it is not suitable or applicable in all situations and for all types of cooperation. They do not apply where a company collaborates with individuals outside an employment relationship (e.g., external service providers such as self-employed individuals), or where they do not want to enter into a more complex corporate structure at the moment or are seeking a more flexible and administratively simpler solution. In such cases, virtual shares (so-called phantom shares) are used in practice.
As their name suggests, phantom shares represent a form of employee participation based solely on a contractual claim, not on actual ownership of shares or interests in the company. Unlike ESOP or direct sale of shares, the employee never acquires shareholder or partnership rights, does not become part of the company’s ownership structure, and is not registered in any public registry. The employee’s participation is thus purely contractual and economic in nature.
The basic idea behind phantom shares is to enable employees to share in a portion of the company’s value – typically the value realized upon the company’s exit – without an actual transfer of shares, i.e., an actual transfer of ownership rights in the company. Employees are promised a bonus, known as a payout, corresponding to the value of their virtual shares or virtual interest upon exit.
Similar to ESOP, a phantom share program can also be divided into several phases. First, there is a so-called virtual grant, during which the employee joins the program and is promised a bonus calculated based on the company’s value according to the number of virtually offered shares or the size of the interest (subject to certain conditions). This is followed by the virtual vesting phase, during which the employee gradually becomes entitled to this virtual participation, typically depending on the duration of the employment relationship and, where applicable, on the fulfillment of performance criteria (an advantage of the phantom program is the ability to contractually tailor the vesting mechanism to the company’s needs).
The economic impact usually becomes apparent only at the time of an exit – such as the sale of the company or a portion thereof, an investor’s entry, a merger, etc. It is at this point that the employee becomes entitled to a payout, the amount of which corresponds to the value of their virtual participation (the value of their virtual shares).
From a tax perspective, phantom shares follow a relatively clear timeline – neither the virtual grant itself nor the vesting process is subject to taxation, as employees do not generate any actual taxable income during these phases. Tax liability arises only at the time of payout, i.e., when funds are actually received. This income is considered income from employment and is subject to taxation under Section 6 of the Income Tax Act (ITA), including social security and health insurance contributions. Phantom programs thus do not benefit from a special tax regime similar to ESOP, which is their greatest disadvantage.
From a legal perspective, a phantom program is based exclusively on contractual documentation. Typically, it consists of a master plan, which sets out the basic rules of the program, and an individual agreement with the employee, which specifies the scope of the virtual interest and the conditions for its exercise. A key role in this documentation is played by the definition of a liquidity event, the method of calculating the payout, and the rules for employee departure. Therefore, even with phantom shares, the concepts of “good leaver” and “bad leaver” (as in ESOP) are commonly used to determine whether and to what extent an employee retains the right to the “vested” or “unvested” portion of their virtual participation.
A significant practical advantage of phantom shares is that they have no direct impact on the company’s ownership structure or its corporate governance. Employees do not acquire voting or information rights, and the program does not lead to dilution of shares.
Direct sale of shares/interests
The direct sale of shares or interests to employees is the most straightforward form of employee ownership. Unlike ESOP and virtual shares, here the employee acquires actual ownership rights – becoming a partner or shareholder of the company with all the rights and obligations associated with that status – Immediately.
In accordance with the rules of the prepared plan and based on the purchase agreement for the actual sale of shares or interests to employees, the employee purchases the specified number of shares or interests at the agreed price and generally becomes their owner immediately. The employee may realize a profit from their participation in the company on an ongoing basis in the form of dividends or in the future upon the sale of interest or the company’s exit.
From a tax perspective, a direct sale is generally less favorable than a qualified ESOP. If an employee acquires a share/interest at a price lower than its fair (market) value, they generally incur taxable income at the time of acquisition, equal to the difference between the fair market value and the price actually paid. This income is typically classified as income from employment and is subject to income tax as well as social security and health insurance contributions, unless one of the tax deferral regimes under the ITA is applied.
From a legal perspective, the direct sale of shares is the most complex form of employee participation. By entering the ownership structure, an employee acquires certain corporate rights that may impact decision-making within the company, access to information, or future transactions. For this reason, direct sales are typically accompanied by provisions regarding restrictions on the transferability of shares, pre-emptive rights, drag-along and tag-along rights, and often also buyback options for the company or other shareholders.
In this context, so-called reverse vesting and its structure play a crucial role. Unlike the vesting period in ESOP, where the employee gradually acquires option rights, in reverse vesting it is the company that gradually loses the right to repurchase a certain number of shares or a specific interest from the employee at a predetermined buyback price (which may be significantly lower than its market value at the time of sale). Therefore, if an employee leaves the company shortly after joining the program, they may be obligated to transfer the interest or shares back. The later they leave during the vesting period, the bigger the interest or the larger the number of shares they will not be forced to sell back to the company, often at a disadvantage. At the end of the reverse vesting period, the employee holds all shares or the entire interest without major restrictions, to the extent defined in the employee share plan or directly in the implementation agreement.
Comparison of individual programs
Tax implications
From a tax perspective, Employee Stock Option Plan (ESOP) represents the most significant shift from previous practice. If the legal conditions are met, the tax liability arises only at the moment of realizing actual economic benefit, typically upon the sale of the share or upon another event defined by law (the “no tax before cash” principle). It is also significant that no social security or health insurance contributions are deducted from this income, which significantly increases net income for employees while simultaneously reducing the employer’s costs.
In contrast, phantom shares function much more simply from a tax perspective, though less advantageously. Neither the grant of phantom shares nor vesting is subject to taxation, as no taxable income arises for the employee at these stages. Tax liability arises only upon payout, i.e., upon the actual withdrawal of funds, at which point this income is considered income from employment. It is therefore subject to income tax as well as social security and health insurance contributions. Phantom programs are not covered by any special tax regime, which means that the tax burden can be significant for larger payouts.[2]
Direct sale of shares/interests to employees is generally the least favorable from a tax perspective. If an employee acquires a share at a price lower than its fair market value, they generally incur taxable income upon acquisition, equal to the difference between the fair market value and the price paid. This income is subject to income tax and social security contributions, unless one of the tax deferral regimes applies. Upon exit, the difference between the sale price and the purchase price is taxed as other income (pursuant to Section 10 of the ITA), unless the conditions for tax exemption are met.
Flexibility of setup
In terms of contractual flexibility, phantom shares offer the greatest freedom. Since they are based exclusively on a contractual claim, vesting, performance conditions, the definition of a liquidity event, and the mechanisms for selling upon an employee’s departure can be adjusted with great flexibility. A phantom share program does not require major corporate interventions or amendments to the articles of association, statutes, or shareholder agreements, which significantly simplifies both its implementation and any subsequent adjustments during operation.
ESOP offers flexibility primarily in terms of economic parameters, but is constrained by the legal conditions of the qualified employer and employee regime and requires alignment with the company’s corporate documentation (including compliance with disclosure obligations to the tax authority, etc.). The relative flexibility here is offset by a higher administrative burden.
Conversely, direct sale is the most limited in terms of flexibility. An employee’s entry into the company’s ownership structure requires precise legal arrangements, coordination with existing shareholders, and often approval by investors. Any changes to the program are subsequently reflected in the company’s ownership structure, which reduces the possibility of operational and rapid adjustments to the structure.
How to choose the best model for a company?
A qualified ESOP is best suited for growth companies and startups with an exit strategy that want to motivate their employees by giving them a share in the company’s future value without burdening them with taxes at a time when they have no actual income.
Phantom shares are suitable in situations where it is not possible or practical to grant actual shares – typically for external collaborators, consultants, in the early stages of a company’s existence, or where maintaining a simple ownership structure is a priority. While flexible, this is a less tax-efficient tool.
Direct sale of shares/interests is primarily suitable for a narrow circle of key individuals, particularly top management or co-founders, and for companies in a more stable phase of operation (i.e., not in their early stages), where the goal is a genuine ownership connection and for which more complex legal and higher tax implications are acceptable.
Conclusion
Employee participation can be a powerful motivational tool, but its appropriate design depends on the company’s stage of development, the type of individuals it is intended to motivate, the planned exit strategy, and the company’s willingness to allow additional individuals to enter the ownership structure. Employee Stock Option Plan may be the most tax-efficient option, but it is not available for all types of arrangements. Phantom shares, on the other hand, offer high contractual flexibility and preserve the ownership structure, but without any special tax benefits. The direct sale of shares or interests represents the most direct form of participation, but at the same time requires the most careful corporate and tax structuring.
If you have any questions regarding employee participation models, the suitability of a specific model for your company, or any related inquiries, we at PEYTON legal are here to assist you.
[1] Section 6a of Act No. 586/1992 Coll., on Income Taxe, as amended, specifies the requirements for so-called qualified employers and qualified employees.
[2] The final tax amount may be affected by an increased tax rate of 23% of the taxable base (instead of 15%), which applies from 2024 to annual income exceeding 36 times the average monthly wage. At the same time, the maximum social security assessment base is capped at 48 times the average wage.
Mgr. Martin Heinzel, partner – heinzel@plegal.cz
Mgr. Ráchel Kouklíková, junior lawyer – kouklikova@plegal.cz
4. 6. 2026