There is a great demand for good employees on the market. Every company needs them. Start-ups too. Especially start-ups. At the same time, start-ups have a clear disadvantage because they cannot pay the same salaries as well-established companies. Are virtual shares the solution to find and retain good employees?
Virtual shares are supposed to be an incentive and motivation to work for a company and to become personally engaged in the company. In the case of start-ups, there is another very important point: often start-ups cannot pay the salaries that well-established companies offer to good employees. At the same time, start-ups often score with exciting projects, more self-development, flexible working conditions and open structures. A virtual share incentive plan can therefore tip the balance and persuade an employee to opt for the start-up and accept a lower salary.
The aim of virtual shares is to lure good employees to the company and to make them stay. On the one hand, the participation of employees in the development and appreciation of the company is supposed to compensate a weaker salary. On the other hand, employees are supposed to stay motivated to move things forward for the company. Virtual shares are based on the presumption that employees become more personally engaged, deliver higher performances and thus boost the development of the company. This is supposed be the case, because thanks to their virtual participation they have a personal interest in increasing the value of the company. At the same time, the participation in the development and appreciation of the company is supposed to create a strong attachment to the company. Because at end of the day, it literally pays off to stay with the company until the end.
From a founders’ perspective, the biggest advantage of virtual participation is that it does not make the employees shareholders of the company. In case of a participation in the share capital of the company, employees subscribe for real shares in the GmbH and become shareholders. Unlike virtual shares, which confer no shareholder status. The employees do not appear in the list of shareholders. They have no voting rights in the shareholders' meeting. And they cannot exercise any minority rights in the shareholders' meeting.
In detail:
For start-ups, it is important to have a proper and short list of shareholders in order to be attractive to investors. Just for that reason, it is usually not an option to issue real GmbH shares to employees.
In addition, shareholders have certain information rights. Maybe you have a 100% transparency and openness to your employees policy. But at some point, there may arise situations in which you do not want to disclose an information to your employees (yet), for example because it is uncertain or extremely sensitive. However, you may have to disclose such information to the shareholders of your GmbH (limited liability company) immediately.
Furthermore, in a GmbH the shareholders’ meeting has the possibility to influence the operational business of the company. Even if your employees do not have a majority in the shareholders' meeting, they could try to influence the operational business. In case, their shareholding represents at least 10% of the share capital, employees could even exert minority rights and thus seriously disturb the business.
Another advantage of virtual shares compared to participation in the share capital with real GmbH shares, is the possibility to split up.
In detail:
In case of a participation in the share capital with real GmbH shares, the prohibition of kicking shareholders out applies. I.e., you cannot simply exclude shareholders from the GmbH against their will. As a result, your employees could terminate their employment contract and still continue to be shareholders in your GmbH.
With a vesting and leaver scheme, you can dilute the problem by linking the shareholder status to the employment contract. However, vesting clauses may not place major obstacles for employees to terminate their employment contract. Therefore, vesting clauses vis-à-vis your employees may not contain extensive provisions and are less effective when it comes to coping with the prohibition of kicking shareholders out.
In the context of a virtual share incentive plan, there is no prohibition of kicking shareholders out, simply because employees do not become shareholders. In case of virtual participation, it is also true that vesting and leaver schemes may not place major obstacles for employees to terminate their employment contract. However, you may pay off an employee after termination with an appropriate redundancy pay, provided that your virtual share incentive plan foresees this possibility. And thanks to this redundancy pay, it is much easier to split up in a virtual participation. The prerequisite, of course, is that the virtual share incentive plan is well designed and allows such redundancy payment.
Are you convinced of the advantages of virtual shares? Then we will now try to understand how virtual participation works. You can find more information on the tax consequences of virtual share incentive plans for employees here.
Obviously, virtual shares are no real GmbH shares. There is no need to make a notary’s appointment for implementing a virtual share incentive plan. No capital increase must be carried out and no real GmbH shares must be transferred. Virtual shares exclusively confer contractual claims. If an exit occurs, employees have a contractual right to a cash payment. This payment claim is generally directed against the GmbH. I.e. virtual shares exclusively lead to an economic dilution. There is no change in the voting rights. Only in the event of an exit, virtual shares deploy an economic effect.
Usually, virtual shares only have an effect in the event of an exit. To put it in a nutshell, only when you sell or liquidate your company.
If you want your employees to receive payments from the virtual share incentive plan before the exit occurs, you should definitely have the tax consequences in mind and seek for good advice.
In the first place, the GmbH pays the claims of the employees from the virtual shares. But finally, the economic burden falls back on the shareholders. The claims from the virtual shares reduce the shareholders' proceeds from the exit. Usually, all shareholders bear the economic effects of the virtual share incentive plan pro rata to their shareholding, i.e. according to their respective participation in the share capital of the GmbH. However, it is also possible that only individual shareholders bear the economic burden from the virtual shares.
It depends on various factors, how high the employees' cash-out payments from the virtual shares are:
You can set the strike price individually for each employee. It ensures that employees only participate in the increase in value and do not benefit from an existing value of the company.
You can find a hypothetical example below:
Of course, the employees do not really have to pay the strike price. They receive the virtual shares without raising any personal capital. In the event of an exit, the strike price is simply deducted when calculating the cash-out payment of the respective employee, so that the cash-out payment is reduced accordingly.
To set up a virtual share incentive plan, in a first step, it is sufficient for the shareholders to adopt a resolution on the creation of a pool of virtual shares. Usually this pool is between 5% and 10% of the share capital of the GmbH. It is recommended that the shareholders simultaneously adopt general terms and conditions containing common provisions equally applying to all employees. In a second step, the employees eligible for the allocation of virtual shares are designated. These employees receive an individual offer specifying the strike price and the number of virtual shares to be allocated to them.
You find a checklist of the steps necessary for the implementation of a virtual share incentive plan here:
From a founders’ perspective, virtual shares have many advantages. They motivate good employees to become personally involved and stay in the company without making them shareholders. This is because no real GmbH shares are issued to the employees. They only participate economically in the appreciation of the company.