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Companies usually pay these shares in cash. Small Business. Company Profiles. Your Money. Personal Finance. Your Practice. Popular Courses. Personal Finance Retirement Planning. Key Takeaways An employee stock ownership plan gives workers ownership interest in the company. ESOP is usually formed to allow employees the opportunity to buy stock in a closely held company to facilitate succession planning.
ESOPs encourage employees to do what's best for shareholders since the employees themselves are shareholders and provide companies with tax benefits, thus incentivizing owners to offer them to employees. Companies typically tie distributions from the plan to vesting. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.
Stock Compensation Definition Stock compensation refers to the practice of rewarding employees with stock options that will vest, or become available for purchase, at a later date. Accrued Benefits Accrued benefits are those benefits earned or accumulated by employees that are not paid immediately, such as sick pay, paid time off, or employee stock plans. Hostile Takeover A hostile takeover is the acquisition of one company by another without approval from the target company's management.
Partner Links. In almost every case, ESOPs are a contribution to the employee, not an employee purchase. An ESOP is a kind of employee benefit plan, similar in some ways to a profit-sharing plan. In an ESOP, a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares.
Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan. Regardless of how the plan acquires stock, company contributions to the trust are tax-deductible, within certain limits.
In other words, starting in , businesses will subtract depreciation and amortization from their earnings before calculating their maximum deductible interest payments. New leveraged ESOPs where the company borrows an amount that is large relative to its EBITDA may find that their deductible expenses will be lower and, therefore, their taxable income may be higher under this change. Shares in the trust are allocated to individual employee accounts.
Although there are some exceptions, generally all full-time employees over 21 participate in the plan. Allocations are made either on the basis of relative pay or some more equal formula. As employees accumulate seniority with the company, they acquire an increasing right to the shares in their account, a process known as vesting.
When employees leave the company, they receive their stock, which the company must buy back from them at its fair market value unless there is a public market for the shares. Private companies must have an annual outside valuation to determine the price of their shares.
In private companies, employees must be able to vote their allocated shares on major issues, such as closing or relocating, but the company can choose whether to pass through voting rights such as for the board of directors on other issues. In public companies, employees must be able to vote all issues. Note that all contribution limits are subject to certain limitations, although these rarely pose a problem for companies. As attractive as these tax benefits are, however, there are limits and drawbacks.
The law does not allow ESOPs to be used in partnerships and most professional corporations. ESOPs can be used in S corporations, but do not qualify for the rollover treatment discussed above and have lower contribution limits. Private companies must repurchase shares of departing employees, and this can become a major expense. Any time new shares are issued, the stock of existing owners is diluted. That dilution must be weighed against the tax and motivation benefits an ESOP can provide.
Finally, ESOPs will improve corporate performance only if combined with opportunities for employees to participate in decisions affecting their work. A benefit plan in another country called an ESOP may be very different.
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When employees depart before all their grants are vested, the unvested grants get lapsed and are returned back to the ESOP pool. However, the vested options are retained by the employee for a certain exercise period that is allowed by the company as per the ESOP scheme terms and conditions. This could be anywhere between a few months to many years.
Of course, the larger time the employee gets for exercise post his departure, the better it is from his perspective because of the high-income tax that is charged at the time of exercise. Check out MyStartupEquity and manage your entire equity stack digitally!
Click here for a blog on the tax outgos of ESOPs! Tweet Share. Request a Demo It is free! Your Name Enter your Name. Your email Enter your Email ID. After this, any remaining options are forfeited. In a private company, this means individuals must quickly decide whether to take the risk of using cash to buy an illiquid asset. Depending on the number of options and strike price , this may be unaffordable. This practice can make leaving a company prohibitively expensive.
A tax bill could add to the financial burden. A few US companies are now adopting extended exercise periods, to appeal to savvy candidates who understand the implication of leaving before an exit. For example, employees may be given an additional year to exercise, per completed year of tenure after their cliff. It thereby helps to build an employee-friendly culture and attract new hires. Our survey of European startups shows a more mixed picture than in the US. As you can see in the chart below, almost half of European startups particularly outside the UK allow leavers to retain their vested options, but without the right to exercise them until exit.
If leavers exercise their options immediately, the number of shareholders grows, which can create major administrative headaches. Furthermore, strike prices in most of Europe are high, and tax liabilities after exercise can be much higher than in the US. Allowing leavers to retain their vested options avoids both these problems, but it leads to a perverse incentive. On the other hand, a few companies in our ESOP survey have the drastic policy of dissolving all options for leavers, whether vested or unvested.
We advise that you tailor your leaver policy according to the specific situation in your country. Your guiding principle should be generosity, wherever possible, giving leavers a realistic opportunity to exercise and become shareholders. But also try to avoid situations where leavers retain all the benefits of staying at zero cost. In Europe, this mechanism is often discretionary.
People fired for major disciplinary breaches, or who leave to join a direct competitor, almost always fall into this group. Quite often it also applies to those who simply choose to leave, or those terminated for poor performance. In fact, bad leaver provisions for stock options are usually tighter than those in employment contracts or covering health and pension benefits.
We strongly support founders following the US approach on leavers, to reassure employees and demonstrate the real value of options. As stated earlier, if employees become cynical about your options program, it ceases to be a benefit, and in fact can become symbolic of a poor culture.
ESOP rules will spell out what happens to employee options during a change of ownership — i. New owners purchase them on the same terms as they are offered to all shareholders, whether that means cash, shares in the new company, or a mixture of the two. During an IPO, shares from exercised options become tradeable shares in the listed company.
Unvested options will generally continue to vest following IPO. In an acquisition, an acquirer will typically put in a new retention programme for key employees, and unvested options lapse. Exceptions are sometimes made for key executives, or the executive team as a whole. In particular, the CEO, CFO and General Counsel are often subject to acceleration provisions, which partially or fully accelerate the vesting terms for their option grants.
This is because these individuals are critical to a successful exit. Without acceleration rights, they have an incentive to delay until their options are fully vested. This protects against new owners who terminate — or effectively terminate — key executives after taking control, thereby preventing them from vesting further options.
Acceleration without a double trigger, and acceleration for non-executive staff, are both rare in the US. They reduce the sale proceeds for each common stock shareholder and as a result are deterrents to potential acquirers. In fact, the risks can be even higher for an acquirer, since your team is often the most valuable asset that they are paying for.
If key members of this team stand to make unexpected additional gains at the moment of acquisition, the risk that they choose to leave the company is particularly high. The European picture is different. One third of European startups offer full accelerated vesting to all employees, which would be unheard of in the US. We recommend at most, double-trigger partial acceleration limited to the executive team only. A broader acceleration policy could seriously impede your chances of a successful exit.
Your startup might begin with a relatively limited number of authorised shares in the thousands, or even hundreds. A lack of local regulation can make it relatively easy for employees to sell exercised options, without approval, on secondary markets. More and more companies are implementing robust restrictions to limit trade in the secondary market. Often, all you have is a gut feeling, and the views of a small handful of advisors.
This chapter, and the next, aims to close this critical knowledge gap. When it comes to employee stock options , there are a few big questions that almost all founders ask, regardless of sector, stage or market:. In this chapter, we will address this set of questions at seed stage. Your company will have few formal processes. So your employees will need to be highly flexible. Compensation packages for your early team need to strike a balance. On the one hand, money will be tight, which makes options an attractive way to compensate your team.
This is a conundrum, and it comes at a time when you want to be focusing on your product. So, like many aspects of running a startup, it can feel more like an art than a science. However, it is becoming more popular, and we recommend it whenever possible. Increasingly, experienced talent will not join a company without a formal stock option offer. Any agreement you make is essentially an IOU — a loose commitment to offer something in the future.
This means you should be extremely careful, ensuring that any offer is clearly understood by both parties. Some founders make the mistake of agreeing equity terms on a handshake, and while this is often done in good faith, it can come back to bite either party. Let your employee know roughly when the grant will be made, and when they can expect to see formal terms.
Moving at startup speed, The Family transforms portfolio startups, special projects and virtual infrastructures into a highly connected community of entrepreneurs, operators and fellow investors across Europe. Few European startups offer equity to all of their early employees, and co-founder Oussama Ammar sees this as a big mistake. The Family takes equity incentives so seriously that it has created Ekwity, a dedicated subsidiary to advise European startups on how to structure employee equity plans so that everyone is happy, committed and actually understands what they own.
Formalised ESOP plans are becoming more common in European seed companies, as the market matures, and competition for talent rises. Founders still wonder how much equity is enough and how to properly size their ESOP. And pre-seed is what seed used to be. Equity is therefore becoming a hot topic for pre-seed companies struggling to attract early hires when cash is particularly tight.
Option grants are made case-by-case, but The Family cautions against being greedy, offering these early hires sufficient equity upside to compensate them for the risk they are taking. It also suggests two approaches for bringing some science to the art:. This would be a special grant, topped up if the contributor becomes a permanent employee after a later fundraise.
Create rules that encourage fairness and retention e. On average, startups that approach us for seed funding have ten employees — but it can be anywhere between zero and twenty. They are also the ones taking the biggest personal risk. Four or five of the first ten employees in a typical European tech startup could be experienced technical hires.
But US benchmarks for seed-stage option grants see table below can be a useful guide — bearing in mind that European employees are generally less willing to compromise on cash compensation in return for more stock options. Salaries have a natural ceiling at seed stage, due to cash constraints.
For experienced hires such as these, the only way to compensate them is through generous stock option grants. European candidates on average are more risk-averse than those in the US, and may be less willing to compromise on salary. For junior hires, salaries tend to be closer to market value, since people still need to pay their bills. Stock options awards are correspondingly lower. The size of your seed round also has a big impact. This gives more flexibility for hiring plans, and salaries.
The grids below provide potential salary levels and option grants expressed as a percentage of salary. We believe these values are realistic for a European seed startup with ambitions to succeed in attracting quality talent. We have developed a 6-box grid to help you calculate grants for employees below executive level — the two axes being seniority and technicality. We have also benchmarked salary information to get you started.
We encourage you to use our OptionPlan app to compare a set of six benchmark percentages for seed startups, and how these translate into grant sizes, ownership, and potential upside value. For example, if you are a solo founder who needs to hire in a wider range of experienced skill-sets to complement your own. Or a deep-tech company that needs highly sought-after machine learning, AI or VR developers.
In the US, it would be unusual for employees hired at seed stage not to receive options as part of their job offer. We believe that all employees at seed stage should receive stock options in Europe. Grant sizes may be lower than those above, if you are paying closer to market salaries, and if you are in a less mature ecosystem. These hires will be less likely to take a pay cut in return for stock options. This chapter details an approach for grants falling into the first four of these categories.
Retention grants are covered in chapter 9. Should you offer your whole team stock options , or only some individuals? The argument for all-employee ownership is simple. It means every hire is invested in your business. It signals that you believe in every employee, and encourages collaboration, and a sense of responsibility.
It also means you can address everyone with a single voice — for example, at off-sites and all-hands meetings. The opposing view, still common in Europe and in late-stage companies, is that many employees prefer tangible benefits — like a bigger salary, pension contributions, health care or a gym membership — to stock options.
Plus, later hires are likely to include more commercial and support staff, who are typically less attracted by equity. Interestingly, however, continental Europe shows an inverted trend. Later-stage companies are more likely to have an all-employee scheme here than anywhere else. It seems that, in Europe, large companies use equity to foster a sense of community that is otherwise lost as they grow. This certainly chimes with our experience. In fact, we find a majority of European companies introduces or re-introduces an all-employee stock option scheme as they look towards a potential IPO.
This award would not apply to employees who receive a larger grant as part of their package, such as C-suite employees. Farfetch knew most employees would struggle to understand a formal legal document. So they produced a simple five-page booklet, explaining the key points. They gave the programme a catchy name — Farfetch for All — and branded the booklet in their house style to make it more engaging.
This proved to be a big hit with the team. The Farfetch team forecast growth over the next three years, and plan to add options through equity-retention programmes on an annual basis. You also need to decide when employees receive stock options. But in Europe, fewer candidates expect them — which gives you more flexibility. Overall, we recommend being consistent for any particular function.
In certain roles, new hires will probably expect an option grant upfront. Such grants usually form a major part of compensation for executive hires C-suite and VP-level , and individuals will almost certainly negotiate this before they join. For these roles, you should always offer the option grant upfront. Some software developers, if not all, will ask about stock options before they join.
To keep things simple and consistent, we suggest granting all developers upfront options too. Other technical hires, such as product managers and data scientists, may expect the same, but the picture varies more by location. Holding off on upfront awards for new hires in other functions has one big benefit: you can find out who the real stars are, and compensate them later accordingly.
This helps you to hold on to your best people, and keep them motivated. US companies rarely have this luxury — but in Europe, with the likely exception of executives and technical hires as discussed above, you can design a system that truly rewards performance.
We recommend reviewing new hires at 6 or 12 months, and tailoring their equity package based on their performance. Depending on your rate of hiring, you may want to make this an annual or bi-annual exercise for all staff. In the US, this ratio is reversed.
This reflects the fact that many European employees receive no options at all. We recommend calculating executive grants as a percentage of your fully diluted equity FDE. Equity for COOs can reach 1. Are they assuming overall responsibility for the day-to-day running of the business? Do they have proven experience in scaling startups?
This reflects the higher pro-portion of tech-enabled business, particularly in e-commerce, in Europe. In the US, there are more pure software businesses, where proprietary technology is the key differentiator. VP grants vary widely based on experience, and the importance of their function. As a rule of thumb: 0. Product and engineering roles will be at the high end of this scale, whereas HR and Finance will attract smaller grants. VP Sales will also be lower, because commissions are typically a large part of their package.
Instead, they negotiate option grants up front, the value of which grows in line with the company valuation. These figures are before dilution , exercise cost and tax have been taken into account. Nonetheless, this example expresses clearly the scale of the financial opportunity on offer. We suggest a different method for calculating, and communicating, option grants outside of the executive team. This is because the numbers can be misleading: a 0.
Instead, your starting point should be base salary. This has two further benefits. Firstly, salary is a reasonable yardstick for the value of each employee. Secondly, it allows you to maintain a standard approach, even with later fundraising.
Grant sizes stay the same in cash terms, but the number of options granted automatically declines as the valuation — and therefore share price — increases. This means you offer consistent rewards, but those who joined earliest see the biggest benefit. Those in the first group tend to receive the highest allocations, with declining average allocations for the second and third groups.
These distinctions can vary considerably from company to company. As you scale, you may well create additional groups to become more fine-grained in your allocations. It will make your option plan more complicated both to implement and explain. Likewise, there are three tiers of seniority defined here, to keep things manageable for smaller companies. Again, as your team grows, you might want to make more detailed distinctions between levels of staff.
We find that option allocations to these two classes of employees are closely aligned. We have developed a 9-box grid to help you calculate grants for employees below executive level — the two axes being seniority, and function.
These percentages are somewhat higher than current European norms. In any case, the relative award sizes between levels and functions should be a useful guide, even if you choose to adjust them proportionally up or down. Our OptionPlan tool will also help you to figure out what percentage allocations are right for you. OptionPlan allows you to choose between six different benchmark allocation levels for grants across your team.
By customising grant levels and hiring plans, you can quickly test and refine your allocation strategy, and check the impact on your overall ESOP. Doing this, we see that they represent 6. Which is the situation that you want — giving some room for manoeuvre, in case your hiring plan needs to be stepped up.
Index Ventures recommends using its Performance Evaluation Matrix to help you calculate stock options awards related to performance and potential. By assessing both on a three-point scale, you can place every employee in a 9-box grid. The percentage breakdowns are a rough example, based on a typical startup. Even if your overall team quality is high, it pays to distinguish the truly great from the good.
You can use the multiplier in each box, together with the base option grant award for each function and level see page 74 , to determine the right grant for each employee. In some boxes, the multiplier is a range. You could also apply the Performance Evaluation Matrix if they are high-performers, to offer them a larger top-up grant.
If their existing unvested stock option grant exceeds this which is possible for early hires , find a different way to reward them. It takes a certain type of personality, often combined with a higher appetite for risk. To help, we recommend that you consider a formal cash:equity trade-off policy for new joiners.
Job offers will feature a mix of cash and options, but with the chance to increase either one, in a fixed ratio. You can keep this ratio simple at It is important to consider how valuable your equity has proven so far — so if you are seed stage, you may offer a ratio, reflecting your higher risk-profile. An employee sacrificing cash in return for options, which vest over four years, should be eligible for a corresponding salary increase the following year.
Or, you may choose to offer the trade-off over consecutive years see table below. A policy like the one above can therefore be a useful part of compensation negotiations with candidates. Particularly in three scenarios, that we have seen repeatedly. In some sectors — particularly finance — existing salaries are likely to be much higher than you will have established in your team.
But stock options are likely to be an important part of the package here. These hires will tend to be much later in your scaling journey, when your valuation will be higher. So you should be able to offer significant grants, without them being hugely dilutive.
Intense competition for technical talent means big hitters like Google and Facebook offer very attractive hiring packages, particularly in engineering, data science, AI and design. It will be almost impossible for you to match the remuneration packages that these companies can offer.
Cash:equity trade- off can help you to close the gap, but accept that you will often struggle to win out if a candidate has a competing offer from a tech giant. In a global marketplace, talent moves around. More and more US executives are coming to Europe. And, given the relative immaturity of the European startup market, you may well end up looking for US talent.
But the price can be high. For a US executive, relocation is a risk and a hassle, and compensation is generally higher in the US than Europe. But we would advise against offering additional benefits to close candidates. It can be a tough, but critical, judgement call. But on a practical level, the tax and regulatory framework they operate in makes a huge difference, too.
Governments use tax as a lever, and many use it to support entrepreneurs. Each country in Europe has its own legal framework and tax code, as well as a unique set of cultural norms. There is no common EU standard. That means the situation needs to be considered country-by-country. We have reviewed and compared stock option treatment across 18 European countries, plus a further 4 outside of Europe.
Can all employees and company types benefit from favourable treatment of stock options? Can options be offered at a strike price below last-round valuation, without adverse tax treatment — reflecting that they are illiquid, high-risk, and non-preferred? When option holders exercise, they become minority shareholders, who may need to be consulted on various company decisions; does this make stock options unattractive to companies?
How does this affect the treatment of leavers? And how much administrative burden and cost is associated with creating and maintaining the plan? Are employees taxed only when they sell shares, or when they exercise — or even at the point of grant?
Which rate is applied — income, capital gains, or something else? Are employee social contributions payable, and if so, how much are they? Is there any financial impact for companies using stock options? If so, when is it incurred? What rate is applied? Are employer social contributions payable, and if so, how much?
The best approach for your company may be influenced by other factors beyond the scope of this handbook. This is a critical factor impacting the attractiveness of stock options. The later they are taxed, the better.
Not only for the employee — but in our opinion, also for governments, because tax-receipts are maximised by targeting the point of greatest financial upside. There are four points at which stock options may be taxed:. A few countries treat the issue of options as a taxable benefit, with tax based on the fair market value of those shares.
This is a strong disincentive for both employers and employees. However, this is more common with other equity-based incentives for example, RSUs than with stock options. Many countries tax employees when they exercise options and buy shares.
Tax is applied to the spread between strike price and fair market value at the time of exercise, and is treated as income rather than a capital gain. Almost all countries tax employees when they sell their shares, but the tax rate applied varies. Some countries treat the profits as income; others, as a capital gain.
In practice, exercise 3 and sale 4 often happen simultaneously. This is important because employees may have to pay higher income tax rates attached to exercise, than lower tax rates attached to sale. The two most common circumstances where this could happen are:. Employees with vested options, when the company exits through a trade sale this is much more common than exit through IPO.
Former employees with vested options, where the company has a policy where leavers retain options, but cannot exercise until an exit this is common in Europe as we saw in chapter 4. In our analysis, countries fell into four groups. These countries have policies which strongly support the use of stock options by startups: at all stages of growth, and for all levels of employee.
Programmes are simple to implement, with minimal cost to companies. Strike prices can be heavily discounted from previous-round valuations, applying US A valuations or better. These countries have implemented programmes to support the use of stock options and similar schemes to reward startup employees. They adopt at least two of the following policies: deferring when tax is payable; reducing the effective tax rate on sale; allowing strike prices significantly below previous-round valuations, and reducing the burden on companies to pay tax or social charges on stock option awards.
However, the scheme is showing its limitations. The maturing London ecosystem now has at least 50 tech startups which have exceeded the company size criteria for EMI including employee limit. These companies are being forced to adopt much less employee-friendly approaches, damaging their ability to effectively reward talent.
These countries scored between 20 and 23 points in our analysis. They have implemented specific policies to support the use of stock options and similar incentives for startup employees. They defer taxation to the point of sale, and apply capital gains tax rates instead of income tax. The main problem with these schemes is their scope — they are not available to all startups. They often only apply at very early-stage.
Once a company outgrows the scheme, the alternatives become much less attractive. We hope to see the scope of these schemes extended in the years ahead, by forward-thinking governments. Encouragingly, in October , the Irish government proposed to broaden its KEEP programme to allow for larger employee option grants. These eleven countries scored 16 or lower, placing them at the bottom of our grid.
Most lack any specific programmes supporting stock options ; administrative barriers make the use of stock options a serious headache for companies, even where there is a specific programme. Even so, startups often do use stock options or similar instruments anyway. They often prevent employees from being able to exercise vested options until a change of control. This avoids the complexities of having minority shareholders on the cap table.
These are simple to implement and administer, and avoid some of the tax burden. But there are disadvantages. Unlike real stock options , VSOPs are generally structured as an employee benefit, which companies can choose to remove without-cause. Leavers often forfeit all rights to virtual options. These differences make savvy hires sceptical. This should be followed up with moves to defer employee taxation to the point of sale rather than exercise.
These individuals would then act as advocates, drawing more top talent into these startup ecosystems. Belgium ranked lowest amongst all the countries that we reviewed, with a score of 10 out of Consequently, Belgian startups issue few stock options. Across Europe and the rest of the world, approaches vary widely. A few European governments are experimenting with startup-friendly policies, including Sweden, Italy, and Ireland.
These need to be bolder. Other countries, including Germany and Belgium, lag further behind with no specific schemes to support startups. Policies drive practice. The onus is on policymakers to work with entrepreneurs, and foster a better environment for both startups and talent. Vibrant startup ecosystems can bring enormous economic benefits in terms of innovation, job creation, and productivity growth. As a policymaker, your actions can be the crucial difference between an ecosystem that thrives, and one that fails.
Over the past decade, policies designed to support startups have focused on the lack of investment. The good news is there is no longer a shortage of capital for truly ambitious founders. There are more seed and venture capital firms active in Europe than ever before, and many of them are flush with funds and eager to invest. These individuals are in high demand from the largest and most deep-pocketed corporations, including those of Silicon Valley and Wall Street.
Startups are unable to compete for this talent with salary and benefits alone. But they can offer employees a meaningful ownership stake, in the form of stock options — rewarding the risk employees take with a young unproven business with a promise of a payout should the startup succeed. While employee ownership is routinely used in Silicon Valley to attract and retain talent needed by startups with limited cash, but near limitless potential, in Europe it is offered inconsistently and at far lower levels.
On average, employees of US startups own twice as much of the companies they work for compared to their European counterparts. Furthermore, European policies all too often penalise businesses and employees for such incentives, with wide variation between national policies and tax frameworks creating a highly fragmented picture across Europe. We believe that closing this disparity, and creating a level-playing field across Europe, will boost the growth prospects of startups and help entrepreneurs secure the best talent.
While entrepreneurs and investors need to do their part to increase the stake given to employees, policy changes are critical to making such incentives feasible and attractive. The treatment of stock options varies widely across Europe. Some countries, such as Estonia, the UK, and France, have regulatory and tax regimes which are at least as favourable as those in the US. The majority, however, including Germany and Spain, lag behind.
Current policies discourage stock options on two levels:. It can be complicated and expensive for employers to grant stock options to their employees, with different schemes required for each European country. Create a stock option scheme that is open to as many startups and employees as possible, offering favourable treatment in terms of regulation and taxation.
Design a scheme based on existing models in the UK, Estonia or France to avoid further fragmentation and complexity. Allow startups to issue stock options with non-voting rights, to avoid the burden of having to consult large numbers of minority shareholders. Defer employee taxation to the point of sale of shares, when employees receive cash benefit for the first time. Reduce or remove corporate taxes associated with the use of stock options.
The remainder of this chapter reviews the policies of 22 different countries, scoring them for their treatment of stock options. We hope that you find it a useful resource for supporting employee ownership, and startup ecosystems, in your own country. We believe that making these changes is critical to attracting talent to startups, and will result in profound and lasting impact on the prospects for European entrepreneurship and innovation.
The most successful startups now take 10—12 years between founding, and becoming publicly-traded multi-billion dollar corporations. The employees in the early years of this journey take the most risk, and sacrifice the most in terms of salary. Few will stay with the company the whole way through.
But they are the lifeblood of any startup ecosystem; most likely to join another startup, or to become founders themselves. Policies that punish these leavers with prohibitive upfront costs and taxes to exercise their stock options , will drive them out of the ecosystem. There is no specific scheme for startups, but the tax regime which applies to all private companies is exceptionally flexible and favourable.
Company can choose strike price , even heavily discounted, without creating any tax liability upon grant. Companies typically prohibit employees from exercising options for at least 3 years after grant, to avoid triggering tax liabilities. Tax beneficial schemes allow for employees to be taxed at capital gains rates at the point of sale. There are no assured valuations, but startups often use US A valuations.
Tax beneficial schemes apply if options are held in an approved trust scheme for 2 years following grant. The grant notice, option agreement and employee consent must be submitted to trustee within 90 days of grant approval. There is no specific scheme for startups. The tax regime which applies to all qualified small business corporations QSBC , private companies controlled by Canadian residents, is very good.
In the Canadian government tried to roll back some of the tax-benefits, but backed down following strong resistance, particularly from the tech sector. For smaller private companies, the most tax-efficient way to reward employees with equity-based incentives is the BSPCE scheme. It was introduced in and amended a few times since. In effect, it is more like an RSU instrument than a pure stock-option, but is tax advantaged. Eligibility for the scheme is fairly broad, has major advantages, and is used by almost all French tech startups.
A few startups also use a tax-advantaged Free Shares scheme, but mostly for employees based outside France. Rules are complex and have changed frequently. First, they immediately widened the scope of the scheme so that non-French companies could also issue BSPCE's to their employees in France. Second, they intend to introduce a 'fair-market valuation' system that will allow startups to offer BSPCE's with a strike price significantly below last-round valuation.
Detailed guidance is unlikely to be issued before Summer The January government announcement offers an assured valuation mechanism. However, detailed guidance will not be issued until Summer Minority shareholders have rights to be informed, but not consulted, if there is already majority support for corporate decisions. Introduced in , and modified a few times since, the Enterprise Management Incentive scheme or EMI, is a highly advantageous stock option scheme which is used by almost all UK tech startups.
For larger startups and private companies, the situation is more complex. However, these are complex to setup, and usually only suitable for senior employees. Independent — i. Unapproved scheme: The default scheme for larger companies.
Available to both employees and non-employees. Growth shares: Individually-designed RSU -like grant dependent upon company hitting sufficiently high hurdles to satisfy tax authorities, e. Companies can match up to two additional free shares for each that is bought.
Unapproved: No assured valuation. Company can choose price, but usually at last-round valuation to avoid additional tax. Growth shares: No assured valuation. Independent valuation is critical for plan to be defensible to tax authorities.
Nominal value will need to be paid for the shares themselves. Minority shareholders have rights to be informed, but not consulted if there is already majority support for corporate decisions. EMI plans are relatively easy to set up and to maintain with standard templates and online registration and submissions. Independent valuations are strongly recommended, but not legally required.
In practice rarely used in all-employee schemes. Tax clawback is otherwise possible. Corporate tax deduction equal to gains made by employees. The costs of setting up and administering the scheme can also be deducted. Unapproved: At exercise, employer national insurance tax due This is sometimes transferred to employees.
Virtual stock option plans are almost always used because there is no tax-favoured scheme, and non-voting shares are not possible. However, virtual options are taxed as capital gain at the point of sale. No specific tax-favoured scheme. However, virtual options are treated very favourably.
Whilst this makes them economically valuable, they do not represent true employee ownership. Most startups allow leavers to retain vested virtual options. Some require exercise within 90 days. Others allow leavers to retain, but not exercise until exit. Companies can choose between two main forms of stock option : incentive stock option ISO and non-qualified stock option NSO. The differences are outlined in the table below. For early-stage companies starting in, or expanding into the US, we recommend setting up an ISO from the outset.
This option is more favourable to employees if held and exercised within specific time frames. The benefits of an ISO outweigh the slightly higher setup costs. Varies according to prefs structure and closeness to exit. At point of sale although in practice execs and senior staff also often taxed at point of exercise. New tax code Section 83 i allows employees except most senior to exercise and defer tax up to five years, or until shares become tradeable.
At point of exercise, may be an income adjustment for alternative minimum tax AMT purposes, up to If holding requirements not met, treated as a NSO, and taxed as income at point of exercise see detail opposite. At point of exercise, subject to income tax 10— At point of sale if later than exercise , subject to short term or long term capital gains tax depending on how long share held. Short term capital gains tax rate is the same as income tax rates. There is no specific scheme for startups, but the tax regime which applies to qualifying private companies is quite good.
It defers tax to sale and at capital gains rates. Fairly straightforward to set up, but startups need to incorporate as Joint Stock companies and not Limited Companies to qualify. Minority shareholders have rights to be consulted on a range of issues.
Options can convert to non-voting shares to avoid complexities. A tax advantaged scheme for innovative startups was launched in , and extended in Under the scheme, options are taxed only at point of sale and at capital gains tax rates. Typically use the valuation from last funding round. It is usually necessary to get tax and legal advice while setting up plans, but they are relatively easy to maintain.
Minority shareholders have extensive rights to be consulted on corporate decisions so most startups use non-voting shares to avoid complexity. Following sustained pressure from local tech entrepreneurs, the Swedish government introduced a tax-favoured scheme QESO in January This scheme allows capital gains tax to be applied to stock options granted by smaller startups up to 50 employees. Employees must remain with the company for 3 years after grant.
Above the 50 employee QESA limit, companies usually use a warrants scheme teckningsoptioner. Employees need to purchase the warrants upfront — a major disincentive. But they then benefit from capital gains tax rates on any upside, deferred to the point of sale. Standard stock options are less often used by startups, since they trigger high income tax and social charges at the point of exercise — and social fees for the company — as well as capital gains tax at sale.
Some later-stage startups including Spotify do use them, as the cost and complexity of using warrants becomes prohibitive. The strike price is usually set at the last investment round price. The employee has to pay for the warrant, based on a Black-Scholes formula.
The scheme defers taxation on stock options to sale rather than exercise, and at capital gains tax rates. KEEP has not been widely used. It remains to be seen if the scheme will catch on. No assured valuation Typically use the valuation from last funding round. Modest discounts are possible, but are not assured. Minority shareholders have the right to be informed, but not consulted, if there is already majority support for corporate decisions.
Most startups have standard US leavers policy — exercise vested options within 90 days or lose them. Leavers need to exercise within 90 days for KEEP treatment, i. Tax favourable schemes were put in place in , but require the assistance of lawyers and tax specialists to ensure eligibility. For startups that are larger, it becomes extremely difficult to grant stock options to more than a handful of senior managers or to more than 20 individuals over a 12 month period without issuing a prospectus or similar offer document.
Employees must hold options or shares for at least 3 years, unless they leave or the Australian Tax Office waives this requirement on a liquidity event. Once a startup is over 20 employees, significant specialist advice is required to ensure compliance with the plan. Employees or leavers who exercise usually have shares held by a nominee to avoid cap table complexity.
In Denmark, almost always, startups use warrants as an employee incentive tool, which are taxed as income at the point of exercise, and as capital gains at point of sale. In , the government introduced a tax-advantaged treatment for stock options in Denmark Section 7H of the Danish Tax Assessment Act.
The new rules means that taxation is now deferred until sale, and subject to capital gains. However, whilst we welcome this change, it is only available to companies with one class of shares, and therefore not catered to VC-backed companies, which usually have two main share classes: common and prefs. Modest discounts are possible, but require a valuation exercise. Leavers who are terminated without cause are entitled to all their options, vested or unvested.
With no tax-favoured schemes in place, Dutch entrepreneurs still often grant options to employees, using the standard tax framework. This means that they are taxed as income at the point of exercise. Despite efforts to position Amsterdam as a startup tech hub, the law has not changed since The impact overall is marginal.
Typically use the valuation from last funding round to avoid additional taxes. Gains on exercise subject to income tax 8. With no tax-favoured schemes in place, Swiss startups still often grant options to employees, using the standard tax framework. This means they are taxed as income at the point of exercise. Typically use the valuation from last funding round with some adjustments taking into account different classes of shares.
Startups frequently issue non-voting shares to employees to avoid bureaucracy with minority shareholders. Not taxed at point of sale because subsequent gains are capital gains which is tax free for Swiss resident tax payers. Income tax up to approx. Efforts to improve the situation continue. For qualifying companies and employees, tax calculated on a taxable benefit of up to NOK , appr. Custom and creative plans are often used, and it is necessary to get tax and legal advice, so costs can be high.
Although Norway allows the issue of non-voting shares companies do not typically choose to use them. At acquisition: Shares purchased at a discount from market value in excess of reduced value due to lock-up are taxed as income up to At sale: Capital gains tax At exercise: Income tax up to Social security These plans are relatively easy to set up, but have not yet stood the test of a liquidity event or been tested in court.
No restrictions apply to a virtual scheme. Typically, virtual options are granted at a nominal value. Virtual plans are fairly straightforward to set up. However, it is unclear how they will be viewed by tax authorities or courts in the case of a significant liquidity event in the country. There is no tax-advantaged scheme in Finland, and no active plans to introduce one. Most startups do set up stock option plans. Options are taxed as income at the point of exercise, and as capital gains at the point of sale if not simultaneous.
The strike price is usually set at the last investment round. At point of exercise, gains are taxed as additional income in the year of exercise 7. As in Germany, most startups use virtual plans, which are not tax efficient for the employee, but are relatively easy to set up. There is a Free Shares scheme, but it creates minority shareholder consultation rights so is not commonly used.
Sometimes conduct a new valuation at implementation. Minority shareholders have extensive rights to be consulted on corporate decisions, which makes use of stock options challenging. Its impact has been limited, and Spanish entrepreneurs and investors continue to face significant challenges. It is not possible to grant stock options in the most common SARL business entity, and as a result Spanish startups usually grant virtual stock options , locally referred to as SARs.
Discounted tax rates are available for SARs held for more than two years. The lack of a tax-advantaged scheme, a high administrative burden, and established norms means most German startups avoid issuing real options in favour of a virtual stock option plan. However, several of the German companies in the Index portfolio have still chosen to set up real stock option plans.
Also solidarity surcharge equivalent to 5. Social security contributions to some extent deductible for income tax purposes. Church tax can be avoided. At point of exercise, subject to income tax, social security contributions, solidarity surcharge and church tax. Stock options are very difficult to use. Belgium uses warrants for employee incentives. These are taxed at grant, but are usually not subject to any further taxation at exercise or sale. These tax laws have stood for 20 years.
A new Belgian Companies Code is expected to enter into force in April which might lead to change. At the moment no further information is available. Almost always use the valuation from last funding round to avoid additional taxes.
An independent valuation is required. Warrant holders have extensive rights, including the right to attend shareholder meetings. They are sometimes grouped in a private foundation to mitigate minority shareholder complexities. Culturally, you may feel all your employees should be treated the same, regardless of where they are.
Spending power, taxation, and other benefits such as vacation allowance, healthcare and pensions can — and will — vary considerably from country to country. On the practical side, regulation and tax requirements around granting options vary considerably between countries. Specialised legal advice on making local ESOP arrangements can be costly and time-consuming. France is a curious case with respect to stock options. However, for companies establishing a French subsidiary, it is financially prohibitive to issue options to French employees, and alternatives will need to be explored — such as Free Shares or a cash bonus scheme.
The first Just Eat website was launched in Denmark in , followed by the UK website which was launched in After the UK, they found Ireland to be the most option-friendly country, followed by Scandinavia, and then the Netherlands. France and Belgium presented the biggest barriers. In France, Just Eat were unable to offer options over the group entity, so they set up a specific scheme for the French subsidiary.
In Belgium, they structured bonuses that mirrored some of the benefits of an option scheme, albeit with higher taxes and less employee protection. Mike explains:. Option strike prices can be more advantageous in some markets than in others. Obtaining discounted strike prices involves getting locally approved valuations, which can be messy: options will be worth different amounts in different places.
These may be revenue forecasts or performance metrics. You also need to be consistent with exchange rates, to avoid accounting gymnastics. The US and UK are the two major markets where you may benefit from discounted strike prices , which are pre- approved by tax authorities.
The UK often allows lower fair market valuations which determine your strike price than in the US. However, if you expand significantly into the US, you will probably end up applying a US valuation, also known as a A, to avoid complexity.
Some European startups apply the A valuation methodology to strike prices they use in certain other countries. This can work, but carries the risk that local tax authorities challenge it at a later point. The tax consequences of this can be very significant. We advise specialist legal advice, and consultation with other founders. Mimecast makes email and data safer for more than 27, businesses and millions of employees worldwide.
The team learned valuable lessons when extending their stock option programme to employees in the US and abroad. In the US, the proliferation of successful tech companies means people expect option grants upfront. Vesting schedules and leaver provisions were particular sticking points: established UK policies were seen as prohibitive in the US.
Mimecast decided to grant options to every employee in each new office, valued or not. Peter explains:. At first, the team calculated their own valuation, using the UK valuation and stock price. But this can be risky, and Peter recommends you leave it to the experts. If an employee takes up a new role in your company in a different country, tax and legal issues can get complicated.
Seek legal advice to avoid nasty surprises. Of course, every company is different — but as you scale, things will get complicated. Calculating equity rewards will become more complex. Again, make sure your lawyers keep track of any cliff -edges that might trigger a change in how you award options. These are outlined in the UK country table on page In recent years, late-stage startups have been taking private funding at extremely high valuations, rather than heading straight for an IPO.
Faced with high strike prices and less valuation upside, stock options become a much less compelling tool for retaining top talent. Particularly when grants exceed ISO limits and so lose their tax advantages. To avoid painful tax bills, private companies usually adopt a special rule, which delays any vesting to coincide with an exit event.
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A vesting schedule for profit sharing works the same way, but since different amounts can be added to the account each year, the numbers may be slightly more confusing. Assume a five year vesting schedule and employer deposits into the account each year are:. After deciding to offer equity shares to employees, the usual procedure is to implement a vesting schedule. This is a major reason why vesting schedules are a great idea for startups or growing businesses.
In the long run, a vesting schedule may save the business money. If an employee leaves the company before the vesting of his equity shares is complete, the unvested shares are forfeited and go back to the company. This winds up saving money on people who are not aligned with the long-term vision of the company. The shares that are given up can then be offered to better candidates.
Also, due to the nature of equity, a vesting schedule usually helps businesses keep great employees. Better employees want to stay and see their equity shares multiply in value while weaker employees, who probably lack the patience to stay at the company for a long period of time, are more likely to prefer shorter-term rewards.
While there are significant advantages of a vesting schedule, there are some disadvantages. Unfavourable or unreasonable vesting terms might drive great candidates away. Great talent may not necessarily want to join a company that has bad equity vesting terms. If the vesting schedule is too favourable for the employees, bad employees may hang around just long enough to become fully vested costing the owner shares of the company and then immediately quit once they receive the shares.
This has a double-whammy effect, since the owner loses the shares and then needs to find replacement candidates quickly. Because of this, outside accounting and tax professionals must be hired to take care of this portion of the business, which increases costs. Overall, the idea of vesting equity shares over time has its pros and cons for startups and small businesses. Each company is different, and the decision of whether to use vesting schedules to award equity shares should be made with guidance of an accounting or financial professional.
This is rare. Graded vesting — This is the most common. The schedule would look as follows: Year 1, April 30th — 0. Saving Money and Retaining Employees In the long run, a vesting schedule may save the business money. ESOPs are merged into another plan by combining the assets for each account balance into a new account balance in the surviving plan. The surviving plan can retain company shares, subject to the fiduciary requirements of the new plan.
Generally, this requires a stricter standard of prudence for holding shares. There are several requirements that must be met when an ESOP is merged into another plan:. Terminating a nonleveraged plan or a leveraged plan where the loan is fully paid is usually relatively simple. The amounts that are allocated are paid out directly to participants or rolled over into a successor plan.
One possible complication occurs if the seller has used the tax-deferred rollover provisions or the lender has used the interest income exclusion provisions. Excise taxes may apply in these cases if plans are terminated too soon. In any termination there are fiduciary issues. The plan sponsor has the right to terminate the plan, but fiduciaries must decide at what price and on what terms.
Shareholders or corporate insiders have a clear conflict of interest situation if they or their employer are repurchasing shares or selling the company. Either an outside trustee should be appointed or, at the very least, qualified, independent advisors should be enlisted.
A new valuation should be performed, one that might change some of the assumptions in the previous valuation. For instance, if the buyer will obtain control by buying ESOP shares, a control price may now be appropriate. Marketability discounts may no longer apply as well. Terminating a leveraged plan where the loan has not yet been repaid is more complicated.
To repay the loan, the company must reacquire the shares or sell them to another buyer. If the shares are not at a price that repays the remaining amount, the company makes up the difference; if selling the shares results in more cash than is needed, a more complicated situation arises.
An amount equal to the basis paid for the shares divided by the proceeds of sale, multiplied by the excess after the loan is paid off, must be allocated to employee accounts on the basis of their relative share balances. In other words, any windfall from the shares goes to employee accounts. Termination or freezing a plan is not a decision to be taken lightly.
This article has only touched on some of the basic legal issues. Competent legal advice is a must. Main navigation What Is Employee Ownership? Web Article.
He had 1 year of esop and vesting service is reinstated. A break in service would be determined based on one. Employer stock geely bolivia Esop and vesting acquired the one-year break in service while they are still employed:. One method is on the to participants after their employment credited and the second is. Sue would have to satisfy the ESOP benefits are paid, to participate and the one termination is temporarily disregarded until was a participant in the of service after being rehired. Since this is the most frequent definition used, the examples in this article assume the vesting. If the plan contains the the eligibility requirements during their "put option" on company stock less frequently than annually over a period no longer than company due to other reasons:. Once such service is completed, form of cash or stock. At a minimum, the put one-year break in service holdout must retroactively participate to the first day of the period as of her first termination date would be permanently lost. Distributions are made in the administrative costs in rare situations.is defined as the process through which employees can apply for shares of the company against their equity grants. If an employee has received an options grant, he/she must carefully read through the company's. currencypricesforext.com › blog › what-is-esop-vesting. Vesting. This discussion refers to "vested benefits," a concept that is unfamiliar to some ESOP participants. Vesting refers to the amount of time an.