Status quo for employee participation
The topic of employee participation plays an important role in practice.
This applies not only to established companies, but also to start-ups and growth companies in particular.
Employee participation is an important lever for success in the competition for talent (“war for talent”).
The aim is to involve employees in increasing the value of the company and a subsequent exit.
With effect from January 1, 2024, the legislator enacted the Future Financing Act, which improves the tax disadvantages of employee participation through genuine shares.
For example, the taxation of the non-cash benefit will be deferred so that the employee does not have to pay tax at a time when they have not yet received any payment from the employee participation (so-called “dry balance problem”).
A “Second Future Financing Act”, which has been available as a draft bill since the end of August, plans further tax relief for Germany as a financial center, such as an increase in the tax-free allowance.
The regulations on employee participation otherwise remain unchanged.
Nevertheless, the framework conditions for German employee profit participation are lagging behind in international comparison.
On the one hand, there are still more favorable tax regulations abroad, particularly in the USA.
On the other hand, the German legal system continues to have disadvantages under company law, particularly in the area of the GmbH legal form, which is popular with start-ups and growth companies.
The preferred model for German start-ups is virtual shareholdings (so-called VSOPs or phantom stocks), and this is unlikely to change in the foreseeable future.
Standards have now emerged in this area that are very easy to deal with in practice.
The tax advantage is that there is indisputably no tax risk at the time the virtual participation is issued and employees can therefore initially participate in a corresponding participation program tax-free.
However, it should not go unmentioned that virtual shareholdings are subject to income tax when they are subsequently sold and are therefore subject to higher taxation than real shares.
Based on the legal form of the GmbH, which is common for young start-ups, virtual participations will remain attractive primarily from a company law and cost perspective.
Compared to virtual shareholdings, real GmbH shares grant irrevocable shareholder rights such as the right to participate in shareholder meetings and information rights vis-à-vis the company.
Only the choice of a more complicated and expensive structure via an intermediary employee company as a pooling vehicle can restrict these rights.
The requirement for notarization when granting or withdrawing genuine employee shareholdings also speaks in favour of employee retention through virtual shareholdings from a cost perspective.
Irrespective of the legal structure of an employee participation program in the form of real or virtual shares or other alternatives such as share options or profit participation certificates, it must first of all reconcile the interests of the company and the employees.
At the same time, however, the interests of the founders and investors must also be taken into account.
The company needs employee participation in order to position itself as an attractive employer on the labor market and to motivate employees in the long term.
At the same time, it can only make payments when there is an inflow of liquidity, i.e. in the event of an exit and, exceptionally, when profits are distributed.
Employees strive for the most attractive conditions possible and therefore want a certain degree of security that they will actually participate financially in the event of an exit.
But also that they do not lose their earned employee shares when they leave the company.
Naturally, founders and investors also want employee participation to be attractive for employees.
However, they also have their own financial interests in mind.
For founders, this means above all keeping an eye on the size of the participation program, the allocation conditions and the consequences for departing employees so as not to be too diluted.
Investors are regularly concerned that the employee shares are only serviced after a certain inflow of liquidity.
— All these interests must be balanced and set out in clear rules.
If this is successful, an employee share ownership program creates real added value for the long-term success of the company.
Prof. Dr. Stephan R. Göthel advises in the areas of M&A/private equity, venture capital and corporate law.
He has extensive experience in national and international company acquisitions, joint ventures, corporate financing (in particular venture capital transactions), corporate restructuring as well as management and employee participation.
In addition, he advises his clients on an ongoing basis on all aspects of corporate law.
Stephan R. Göthel advises companies from a wide range of sectors, from start-ups to market leaders, as well as investors (business angels, venture capital investors, private equity investors and family offices).
As a trusted advisor to many clients, his aim is to provide the best possible advice with clear recommendations at all times — pragmatic, solution-oriented and with a focus on the client’s business objectives.