Unlisted Company Equity Incentive Plan - Virtual Equity Incentive Plan
Authors | Attorney Gao Shengjie, Attorney Wang Chao
Preface
In China, the concept of virtual equity can be traced back to the “shen gu” system practiced by Shanxi merchants in ancient times. During the Ming and Qing dynasties, Shanxi merchants widely adopted this system, dividing shares into “yin gu” (owned by investors) and “shen gu” (owned by employees). Among them, holders of profit-sharing shares participate in profit distribution based on their managerial and operational capabilities, but do not hold any actual ownership.
This incentive model enabled Shanxi merchants to stand out in commercial competition, making them among the earliest adopters of the virtual equity incentive model among Chinese business entities. Since then, as the modern corporate governance system has continued to evolve, virtual equity incentives have come to occupy a prominent position in modern corporate equity‑based compensation schemes—particularly for non‑listed companies—owing to their numerous advantages, including the fact that they do not alter the company’s capital structure, the recipients of such incentives do not bear the risks associated with operational decision‑making, and the arrangements are flexible and easy to implement.
This article will examine and analyze the design rationale of the virtual equity incentive model, as well as the key review considerations for companies planning to go public, with a focus on the model’s fundamental principles and core advantages.
The basic concept of virtual equity incentives
(I) Definition of virtual equity incentives
As for the definition of virtual equity, there is currently no clear consensus in either academic circles or legal regulatory frameworks. From the perspective of practical implementation and underlying principles of virtual equity incentive schemes, “virtual shares” generally refer to a type of non‑registered, internally issued stock that does not confer shareholder status under corporate law, carries no voting rights, but entitles the holder to dividend distributions. Such arrangements are typically governed by internal agreements entered into by employees and the company based on their mutual consent, taking into account factors such as the employee’s position and capabilities.
Taking Huakin Technology (603296) as an example, during the inquiry process, Huakin Technology described the nature of its phantom shares as follows: Phantom shares are an incentive instrument created by the founding shareholders and granted to eligible employees, entitling them to economic benefits—including dividends received from the founding shareholders and any appreciation in the value of the incentive rights—thereby conferring certain financial gains. However, recipients do not thereby become shareholders of the issuer, nor do they acquire any shareholder rights, such as voting rights.
Since all incentive agreements are entered into between the founding shareholders and the incentive recipients, with the founding shareholders assuming the obligation to perform, the economic rights associated with the phantom shares are realized through certain economic benefits—such as dividends—transferred from the company by the founding shareholders. Furthermore, the funds for the subscription and repurchase of phantom shares are managed in a closed-loop system through accounts controlled by the founding shareholders, rather than being received or disbursed through the issuer’s accounts. Accordingly, the issuer’s phantom share incentive plan constitutes an internal contractual arrangement between the founding shareholders and the relevant incentive recipients for sharing the company’s dividends and the appreciation of incentive rights, among other economic benefits.
(II) Main Characteristics of Phantom Equity Incentives
1. Internality
Since the virtual equity incentive model constitutes an internally structured contractual arrangement that confers economic benefits, its beneficiaries are limited to the company’s employees and are not extended to external parties.
2. Virtuality of Equity
Virtual equity is not equity that, under corporate law, requires registration with the relevant authorities; shareholders holding virtual equity are also not shareholders in the traditional sense under corporate law.
3. Limitations of Rights
The incentive recipients do not hold shareholder status, are not entitled to voting or decision-making rights, and may not participate in the company’s management; they are solely entitled to dividend income. Typically, even among a company’s internal employees, the free transfer of phantom equity is prohibited.
(III) Differences between virtual equity incentives and other incentive models
(IV) Core Advantages of Phantom Equity Incentive
1. Does not affect the stability of the equity structure:The virtual equity incentive model does not involve amending the company’s articles of association or altering the equity structure, thereby effectively safeguarding the controlling shareholder’s voting rights from dilution. At the same time, since the equity structure has remained unchanged, the company’s decision-making efficiency will not be compromised, and the interests of the company’s owners and management are more closely aligned.
2. No limit on the number of shareholders:According to the Company Law, the number of shareholders in a limited liability company may not exceed 50, and the number of shareholders in a joint-stock company may not exceed 200. Under a virtual equity incentive model, the eligible participants can bypass these personnel limits, making it easier to achieve the goal of enabling a larger number of employees to participate in the incentive program by enhancing their job skills and work efficiency.
3. Flexible operation:In the case of virtual equity incentives, the pricing, allocation quantity, performance evaluation criteria for recipients, incentive cycle adjustments, and exit mechanisms can all be determined or modified through mutual agreement with the recipients. This flexibility further enables the company to continuously refine its incentive models in alignment with its strategic planning as it evolves.
4. High risk-reward ratio:For employees, regardless of whether the company is in its early startup phase, rapid expansion, or mature operations, recipients of virtual equity incentives can receive dividend income with minimal or even no upfront capital contribution, and they are not required to bear the company’s debts or other risks to the same extent as shareholders with full ownership rights. As a result, the risk-adjusted return on investment is significantly higher than with other equity incentive schemes.
(V) The applicability of virtual equity incentives
When implementing equity incentive plans, non-listed companies often face practical challenges such as sensitivity over equity structure and reluctance to see it diluted, restrictions on the number of shareholders under the Company Law, and insufficient cash flow to cover the actual costs of equity-based incentives. Virtual equity incentives, owing to their characteristics—such as not involving actual changes in equity ownership, not altering the company’s governance structure, and requiring no registration with the relevant authorities—have become a particularly suitable incentive tool for such enterprises.
Especially for small and medium-sized enterprises and companies planning to go public, the advantages of virtual equity are even more pronounced.
Most small and medium-sized enterprises are either family-run or controlled by their founders, with a simple yet highly stable equity structure. If equity-based incentives are granted in the form of actual shares, not only would it be necessary to amend the company’s articles of association and complete the relevant business registration, but the process would also be cumbersome and could potentially give rise to shareholder disputes. Virtual shares, which grant dividend rights through internal agreements, can effectively retain core talent without disrupting the existing equity structure.
For companies planning to go public, the securities regulatory authorities impose stringent requirements regarding clear equity ownership and the absence of any disputes over property rights. Directly granting equity interests may give rise to disputes—such as those arising from employee departures or nominee holding arrangements—thereby impeding the company’s IPO process. Virtual shares can be structured as a transitional arrangement, for example, by stipulating that “virtual shares must be cleared or converted into actual shares held through an employee stock ownership platform within a specified period prior to the submission of the IPO application.” This approach not only satisfies regulatory review requirements but also provides sustained incentives for the team up to the critical IPO milestone.
Furthermore, although listed companies generally employ equity-based incentive instruments such as restricted stocks and stock options, in certain specific scenarios—such as when the controlling shareholder is reluctant to dilute their equity stake or when there is a need for rapid, short-term incentives for project teams—phantom stock (whose payouts are typically based on the company’s share price or net profit) can still serve as an effective supplementary incentive mechanism.
However, whether the company is privately held or publicly listed, the incentive effectiveness of phantom equity is highly dependent on the company’s profitability and its ability to honor contractual obligations. Because phantom shares do not confer the property rights and legal protections associated with actual equity, the realization of dividend payments and capital appreciation is entirely dependent on the company’s operating performance and the integrity of its management.
If a company lacks stable profitability and a solid reputation, even under the aforementioned circumstances, virtual shares will struggle to deliver their intended motivational effect.
Legal Attributes of Virtual Equity Incentives
(I) Regulatory documents concerning virtual equity incentives
As evidenced by the aforementioned regulatory documents, China has not yet enacted specific laws and regulations governing virtual equity. Consequently, there is no clear legal basis for determining the legal nature of virtual equity, and in practice, such determination typically requires an assessment based on the terms and implementation of the virtual equity incentive plan.
(II) Judicial View: Labor Remuneration or Equity?
In light of the foregoing, virtual equity is not subject to business registration, does not involve any actual change in the company’s equity, and the recipient thereof does not possess ownership, voting rights, or full disposal rights; moreover, it typically lapses automatically upon the recipient’s departure from the company, as stipulated in the agreement between the company and the employee. Consequently, in practice, virtual equity is often regarded as a special form of labor compensation.
Taking the judgment (2018) Hu 01 Min Zhong 6881 rendered by the No. 1 Intermediate People’s Court of Shanghai as an example, the court held that, with regard to the equity incentives and other terms set forth in the Offer Letter, the parties had indeed agreed that the equity in question could not be transferred to third parties and was subject to repurchase by the majority shareholder.
However, Zhishang Company never transferred the corresponding equity interests to Li and did not register them in the company’s shareholder registry. The parties have agreed on matters such as onboarding equity, incentive equity, and equity dividends, all of which are denominated in “cash shares” of a specified value; this is distinct from the equity rights enjoyed by shareholders under the Company Law.
As determined by the court of first instance, Li is entitled only to claim from Zhishang Company the cash-value equivalent of the virtual equity held by him; such compensation constitutes a special form of remuneration that Zhishang Company provides to Li as an employee.Therefore, it clearly falls within the scope of a labor dispute rather than a corporate equity dispute.。
Therefore, the provision in the Offer of Employment stipulating that the so-called shares may not be transferred to any third party and must be repurchased by the majority shareholder is without substantive effect.
(III) Other determinations
1. Profit Distribution
Taking Huaqin Technology as an example, its prospectus for the initial public offering provides the following explanation regarding the nature of the company’s virtual equity: The virtual stock incentive program implemented by the issuer in the past differs significantly from corporate equity in terms of the nature and content of the rights, the obligations and responsibilities of the holders of virtual shares, the flow of funds, and the implementation procedures. The virtual shares granted by the founding shareholders to employees are merely a “virtual” incentive instrument created by reference to the form of corporate equity and do not constitute full-fledged corporate equity entitling the holder to all shareholder rights.The essence of virtual stock incentives is an internal agreement between employees and the founding shareholders regarding the sharing of corporate dividends and other earnings.
2. Option-like arrangements
In its response to the Shanghai Stock Exchange’s Inquiry Letter No. [2023]19 issued by the Science and Technology Innovation Board Review Department, Kangxi Communication (688653) stated that the issuer’s virtual shares comprise restricted stocks and stock options. Although the virtual shares granted by the issuer entitle the grantees to dividend rights and appreciation gains, they do not constitute equity or shares within the meaning of the Company Law. The recipients of such incentives are not registered as shareholders of the company and do not enjoy shareholder rights such as voting rights or nomination rights.
When the issuer granted virtual shares to the incentive recipients, revoked their eligibility to subscribe for virtual shares, and canceled all virtual shares previously granted to them, no registration with the relevant industrial and commercial authorities was carried out.The virtual shares issued by the issuer essentially constitute a right granted to employees to acquire the company’s equity at a predetermined price. Upon the company’s unified arrangement, such virtual shares may be converted into registered equity (real shares) in accordance with an agreed-upon ratio, enabling the incentive recipients to hold equity indirectly through an employee stock ownership platform., rather than the corporate equity/shares as defined under the Company Law or the securities as defined under the Securities Law.
3. Equity nominee holding
In its response to the Shanghai Stock Exchange’s Inquiry Letter on Review [2023] No. 505, Changguang Chenxin (pre-disclosure) stated that holders of virtual equity are entitled to dividend rights corresponding to their virtual equity interests, as well as to any capital gains arising from subsequent transfers of such equity. Based on confirmations obtained from interviews with Wang Xinyang and the holders of virtual equity, or upon receipt of their confirmation letters,Relevant personnel shall enjoy full shareholder rights with respect to the virtual equity they hold, including the right to dividends, the right to transfer proceeds, and voting rights, among others, and shall entrust Wang Xinyang to exercise such shareholder rights, including the voting right.There are no objections, disputes, or controversies among the parties regarding the virtual equity.
Design Concept of the Virtual Equity Incentive Plan
(I) Basic Approach
The fundamental principles of the virtual equity incentive plan are to ensure legality and compliance, deliver tangible benefits, facilitate a smooth transition, and align rights with responsibilities. The plan is designed to support the company’s overall development strategy, with a performance‑growth orientation that takes into account capital market dynamics. While retaining core talent, it effectively constrains participants through performance evaluations and adherence to company policies, thereby achieving a balance between management and incentives. Specifically, the design of a virtual equity incentive plan can be formulated along the following lines:
In addition, the implementation of the virtual equity incentive plan must strictly comply with the company’s articles of association, follow the applicable internal review and decision-making procedures, and designate relevant personnel to oversee the signing of agreements and the execution of the incentive plan. A well‑structured procedure not only satisfies the requirement of “clear equity ownership” but also helps to mitigate legal risks.
(II) Interpretation of Huawei's TUP Incentive Plan
Since 2013, Huawei has undergone several institutional reforms to its employee stock ownership plans, and, while retaining the virtual restricted stock scheme, the company has also introduced the TUP incentive program. This plan is a medium- to long-term profit-sharing and incentive program. Each year, eligible employees may receive a specified amount of TUP incentives based on their performance, granting them the right to monetary payouts over the next five years, which include annual dividends and end-of-period appreciation gains. Upon the expiration of the five-year period, the TUP for that cycle will automatically be reset to zero, allowing for the continuous rolling implementation of TUPs across different cycles.
Key Audit Considerations for Pre-IPO Companies Implementing Phantom Equity Incentives
Due to the numerous misconceptions regarding the legal nature of virtual equity incentive plans, their implementation is prone to compliance and tax risks, and may even give rise to disputes over shareholders’ rights and interests. Therefore, regulatory authorities will pay close attention to the virtual equity incentive arrangements of companies planning to go public. Upon reviewing regulatory cases from the past three years, the inquiry focuses of the review authorities regarding virtual equity incentives can be categorized as follows:
Conclusion
Maintaining the stability of core personnel is crucial for a company’s development. For firms in the growth or expansion phase, virtual equity incentive plans are relatively easy to implement and can serve as an initial mechanism for aligning the interests of the company and its employees. During implementation, the virtual equity scheme can be adjusted, and virtual equity can be converted into actual equity, enabling a flexible, dynamic development model that allows both entry and exit. This approach helps retain key talent—mid‑ and senior‑level managers and core technical personnel—who drive performance growth and product innovation.
References—scroll down to view.
1. “A Study on Legal Issues in Virtual Equity Incentives for Non-Listed Companies” by Zhang Wen;
2. “A Study on Corporate Equity Incentive Programs: A Case Study of Huawei Technologies Co., Ltd.” by Chen Can;
3. “A Study on the Legal Issues of Virtual Equity Incentives in Limited Liability Companies” by Lu Rong;
4. “Analysis and Practice of Phantom Shares in Non-Listed Companies: A Case Study of Company X” by Wu Binghua;
5. “Qualitative Observations and Regulatory Insights on Phantom Shares – Focusing on the Protection of Phantom Shareholders” by Xue Qiang;
6. Case Study on H Company’s TUP Incentive Plan, Liu Yaxuan;
7. “Analysis of Eleven Typical Cases: Core Elements in Determining the Dispute Nature of ‘Equity Incentives’ in Non-Listed Companies” — Tongshang Research;
8. “Key Considerations in IPO Reviews: Is a ‘Virtual Equity’ Really Equity?” — Global Law Office
Author
Introduction
Gao Shengjie
Senior Equity Partner, Zhiheng (Dalian) Law Firm
Attorney Gao ShengjieGraduated from the Law School of Jilin University, practiced at JunZeJun (Shenzhen) Law Firm and Haotian (Shenzhen) Law Firm in Beijing, and subsequently joined Guangdong Zhiheng (Dalian) Law Firm in May 2025, officially returning to his hometown of Dalian.
Business Area:
Capital markets dispute resolution, corporate equity investment and mergers & acquisitions, corporate finance, debt recovery, and corporate legal affairs.
represents performance:
Non-litigation practice — comprehensive dispute resolution project involving restricted equity for a biotechnology company in Shenzhen; special legal advisory project on investment-related earn-out agreements for a new materials company in Shenzhen; management‑buyout project for an electrical appliance manufacturing company in Shenzhen; debt restructuring for a real estate company in Hunan; pre-restructuring project for a photovoltaic joint‑stock company in Gansu, among others. Provides ongoing or ad hoc legal advisory services to Guangwei Technology Co., Ltd., Tianhai World Satellite Communications Co., Ltd., Lingyu Technology Co., Ltd., Haiyue New Energy Co., Ltd., and other companies; also prepares Chinese legal opinions on behalf of Canadian Chinese immigrants.
Litigation Practice — As the lead counsel, I have handled a number of complex cases, including equity disputes between Shenzhen-based New Materials Co., Ltd. and its actual controller and investors; contract disputes involving Shenzhen Huiji Group Co., Ltd. and multiple construction companies (approximately 50 cases); a series of litigation matters concerning material payment claims between Shenzhen Hong Construction Co., Ltd. and a listed company (including nearly 30 subrogation disputes); a case involving the confirmation of shareholder status at a Shenzhen trading company; a series of financial loan contract disputes for a commercial bank; as well as dozens of labor dispute cases arising from matters pertaining to our long-term legal advisory clients.
Contact phone number:
Work email:
gaoshengjie@zhihenglawyer.com
Wang Chao
Senior Partner, Zhiheng (Dalian) Law Firm
Attorney Wang ChaoA graduate of Southwest University of Political Science and Law, he currently serves as a member of the Legal Services Special Committee of the Dalian Council for the Promotion of International Trade (Dalian International Chamber of Commerce) and a member of the Business Innovation and Development Special Committee of the Dalian Lawyers Association. His areas of expertise include corporate legal advisory services, compliance for state-owned enterprises, mergers and acquisitions/restructuring, and legal matters related to corporate investment and financing.
Has extensively participated in projects involving asset restructuring, legal due diligence, mergers and acquisitions, and corporate internal control and governance for large state-owned enterprises and private companies. Leveraging extensive experience in non-litigation practice and a deep understanding of diverse transaction structures, we swiftly identify core project risks, pinpoint key leverage points in the transaction, and design optimal, compliant, and commercially viable solutions for our clients, thereby maximizing their business value.
Business Area:
Corporate Legal Counsel, M&A and Restructuring, Corporate Investment and Financing
represents performance:
● Provides ongoing legal advisory services to numerous enterprises, with a client base primarily comprising government agencies and large state-owned enterprises. Has rendered legal services to entities such as the Dalian Municipal Public Utilities Service Center, China Railway Dalian Metro Line 5 Co., Ltd., China Merchants Taipingwan Development & Investment Co., Ltd., and the Dalian Kai Re Branch of State Power Investment Corporation Northeast Electric Power Co., Ltd.
● Provided legal due diligence services for multiple M&A projects involving state-owned enterprises.
● Providing legal advisory support for government special-purpose bond projects.
● Provided specialized legal services for comprehensive compliance management throughout the entire lifecycle of a hospital infrastructure construction project.
● In government‑concessioned projects, we provide comprehensive legal services to the government and project companies, including the design of resolution strategies and facilitation of communication and negotiation during contract performance.
Contact phone number:
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