Status quo of employee participation – 3 questions to smart minds

18.09.2024

In an interview with the FYB Financial Yearbook Germany, Prof. Dr. Stephan R. Göthel LL.M. (Cornell) answers three questions on the topic ‘Status quo of employee participation’.

The topic of employee participation is particularly interesting for young companies that can hardly keep up with established companies in terms of salary. There are different models that one should inform oneself about and certain conditions must also be adhered to.

1. What is the current status of employee participation in practice?

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. Employee participation is an important lever for success in the competition for talent (‘war for talent’). The aim is to involve employees in the increase in the value of the company and a later exit.

With effect from 1 January 2024, the legislator has enacted the Future Financing Act, which improves the tax disadvantages of employee participation through real shares. To this end, for example, the taxation of the monetary advantage is spread over time so that the employee does not have to pay taxes at a point in time when he has not yet received a 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 breaks for Germany as a financial centre, such as an increase in the tax-free allowance. The regulations on employee participation remain unchanged in all other respects.

Nevertheless, the conditions for employee participation in Germany are lagging behind internationally. On the one hand, more favourable tax regulations continue to exist abroad, particularly in the USA. On the other hand, there are still disadvantages under German company law, especially in the area of the legal form of the GmbH, which is popular with start-ups and growth companies.

2. Which model is preferred in practice?

The preferred model for German start-ups is virtual shareholdings (so-called VSOP or phantom stocks), and this is not likely to change in the foreseeable future. Standards have now been developed that are very easy to work with in practice. The tax advantage is that at the time of issue of the virtual shareholding, there is indisputably no tax risk and employees can therefore initially participate in a corresponding shareholding programme free of tax. However, it should not go unmentioned that virtual participations are subject to income tax when they are sold and are therefore taxed more heavily than real shares.

Based on the legal form of a GmbH, which is common for young start-ups, virtual participations will remain attractive primarily from a corporate law and cost perspective. In contrast to virtual participations, real GmbH shares grant irrevocable shareholder rights such as the right to participate in shareholder meetings and information rights vis-à-vis the company. These rights can only be restricted by choosing a more complicated and expensive structure involving an intermediate employee company as a pooling vehicle. The requirement of notarisation when granting or withdrawing genuine employee participation also tends to favour employee retention through virtual participation from a cost perspective.

3. And what ultimately characterises an attractive employee participation programme?

Regardless of the legal form of an employee participation programme – real or virtual shares or other alternatives such as share options or profit-sharing certificates – it must first align 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 to position itself as an attractive employer in the labour market and to motivate employees in the long term. At the same time, it can only make payments when liquidity is available, i.e. in the event of an exit and, exceptionally, when profits are distributed. Employees are seeking 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 they also want to be sure that they will not lose the employee shares they have earned when they leave the company.

Naturally, company founders and investors also want employee ownership to be designed in an attractive way 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 programme, the allocation conditions and the consequences for employees who leave the company, in order to avoid excessive dilution. Investors are regularly concerned that employee shares are only served after a certain liquidity inflow. All these interests must be balanced and cast in clear rules. If this is successful, an employee participation programme creates real added value for the long-term success of the company.

Click here for the interview: Status quo bei der Mitarbeiterbeteiligung - FYB Financial Yearbook (in German)

FYB Financial Yearbook Germany

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