Good employees are highly competitive. Every company needs them. Start-ups too. Especially start-ups. At the same time, start-ups have a clear disadvantage because they cannot pay as high salaries as established companies. Are virtual employee participation schemes the solution to attracting and retaining good employees?

What are the advantages of virtual employee participation?

Virtual employee share ownership schemes are intended as an incentive and motivation to work for a company and make a personal contribution to the company. In the case of start-ups, there is another very important point: start-ups often cannot pay the salaries that good employees are offered by established companies. At the same time, start-ups often score points with exciting projects, more self-development, flexible working conditions and open structures. A virtual employee participation program can now be the grain in the scales that persuades an employee to opt for the start-up and accept a lower salary.

Incentivisation and loyalty to the company

The aim of virtual employee participation is therefore to attract good employees to the company and keep them on board. The idea is to compensate for a lower salary by allowing employees to participate in the development and increase in value of the company. On the other hand, employees should be motivated to drive the company forward. Virtual participation is based on employees becoming more personally involved, doing more and thus boosting the company’s development. Precisely because they have a vested interest in increasing the value of the company due to their virtual participation. At the same time, the aim is to create a strong bond with the company through participation in development and value enhancement. Because it pays off in the truest sense of the word to stick with it to the end.

Without co-determination rights under company law

Thanks to the founders’ glasses, the great advantage of virtual participation is that it does not turn employees into shareholders. In the case of a so-called open participation, where employees receive real GmbH shares, the employees also become shareholders. Virtual shares, on the other hand, do not confer shareholder status. The employees do not appear in the list of shareholders. They have no voting rights at the shareholders’ meeting. And they cannot exercise minority rights in the shareholders’ meeting.

In detail:

The list of shareholders

It is important for start-ups to have a clean and clear list of shareholders in order to be attractive to investors. This reason alone rules out the possibility of involving employees with real shares.

Information rights

Shareholders also have certain information rights. Maybe you want to be 100% transparent and open with your employees. But perhaps there are situations in which you don’t want to pass on information to your employees yet, for example because it is unsafe or particularly sensitive. However, you may have to pass them on to the shareholders of your GmbH immediately.

Co-determination and minority rights

In addition, in a GmbH, the shareholders’ meeting can influence the operational business. Even if your employees do not have a majority in the shareholders’ meeting, they could try to influence the operational business. With a stake of at least 10% of the share capital, employees could even assert minority rights and thus seriously disrupt the business.

With the option to separate

Another advantage of virtual participation compared to open participation with real GmbH shares is that you can separate again.

In detail:

The prohibition of dismissal

In the case of an open participation with real shares, the so-called prohibition of termination applies. This means that you cannot simply exclude a shareholder from the GmbH against his will. As a result, your employee could terminate his employment relationship but continue to be a shareholder in your GmbH.

Why vesting clauses do not offer reliable protection here

A vesting clause can mitigate the problem of the prohibition of dismissal by linking the shareholder position to the employment relationship. However, vesting clauses must not make it excessively difficult for employees to terminate their employment contract. For this reason, vesting clauses are only permitted to a lesser extent in relation to employees and only help to a limited extent in overcoming the prohibition on dismissal.

The settlement option for virtual employee participation

In a virtual participation program, there is no prohibition on dismissal because the employees do not become shareholders. The same applies here: vesting clauses must not make it excessively difficult to terminate the employment relationship. However, you can compensate an employee after termination with an appropriate payment if your virtual participation program provides for this option. And thanks to this settlement option, it is much easier to separate again in a virtual participation program. The prerequisite is, of course, that the virtual participation program is well designed and provides for a settlement option.

How virtual employee participation works

Are you convinced of the benefits of virtual employee participation? We will now try to understand how virtual participation works. You can find more information on the tax consequences of virtual employee participation here.

Virtual shares are not real GmbH shares

As the name suggests, virtual shares are not real shares. You can set up a virtual employee participation program without a notary appointment. There does not have to be a capital increase, nor do real shares have to be transferred. Virtual shares establish a purely contractual claim. In the event of an exit, the employees are entitled to payment. This payment claim is generally directed against the GmbH. This means that virtual shares lead to a purely economic dilution. There are no changes to the voting rights. The virtual shares only have an economic effect in the event of an exit.

When do the virtual shares have an economic impact?

In most cases, the virtual shares only have an effect in the event of an exit. To put it simply, only when you sell or liquidate your company.

If you want your employees to receive payments from the virtual participation before the exit, you should definitely keep an eye on the tax consequences and seek good advice.

Who pays for the employees’ entitlements from the virtual shares?

The GmbH does pay the employees’ claims from the virtual shares. However, the economic burden falls back on the shareholders. The claims from the virtual shares reduce the shareholders’ proceeds from the exit. As a rule, all shareholders bear the economic effects pro rata, i.e. in proportion to their respective share in the GmbH’s share capital. However, it is also possible that only individual shareholders bear the economic burden of the virtual employee participation program.

How high are the demands of employees from virtual shares?

How high the demands of the employees from the virtual shares are depends on various factors:

the amount of the exit proceeds (e.g. the purchase price from a share deal),
the amount of any existing liquidation preferences,
the number of virtual shares, and
from the strike price.

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 company value.

Here is a fictitious example:

Employee A received virtual shares in January. The company was worth EUR 2 million at the time. Its strike price is set at 200 euros.
Employee B receives virtual shares in December. The company is now worth EUR 4 million. Its strike price is set at 400 euros.

Of course, employees do not actually have to pay the strike price. You do not have to raise any capital to receive the virtual shares. In the event of an exit, the strike price is simply deducted from the calculation of the respective claim, so that the payout amount is reduced accordingly.

How is a virtual employee participation program set up?

To set up a virtual employee participation program, it is sufficient for the shareholders to decide in a first step to create a pool of virtual shares. This pool is usually between 5% and 10% of the GmbH’s share capital. It is recommended that the shareholders simultaneously adopt general contractual conditions that regulate the fundamental issues for all employees equally. In a second step, the employees who are to receive virtual shares are selected. These employees then receive an individual offer in which the strike price and the number of virtual shares that the respective employee is to receive are specified.

Here is a checklist of the steps you need to take to set up a virtual employee participation program: