Employee Participation in German Startups: Introducing An Alternative to ESOPs and VSOPs

Employee participation has become an established tool for employee retention and motivation in German companies. The purpose of employee participation is to allow the team to share in the success of the company, which can strengthen motivation and loyalty to the company.

To implement employee participation in a company, participation programs are often created. They define the framework and the legal structure of the participation. Two well-known forms of participation programs are the ESOP and the VSOP.

In this blog post, you learn what they are, the pros and cons of ESOPs and VSOPs, and an interesting alternative.

Key facts:

• Employee participation is an exciting way for startups to attract talent and engage and motivate their team.
• ESOPs and VSOPs are established forms of employee participation programs that have different advantages and disadvantages.
• GmbH tokens provide an alternative to ESOP and VSOP programs.

Benefits of Employee Participation for Startups

Employee ownership is particularly interesting for startups, as they are often unable to pay salaries that can compete with those of larger companies. They can be a good way to create an incentive without getting into cash flow problems.

There are also other advantages, which are listed below.

Motivation and engagement: The team feels more connected to the company when they have a stake in its success.

Talent attraction: Employee participation can help attract and retain talented employees because they share in the long-term success of your startup.

Increase productivity: Employees who share in the success tend to be more productive and innovative.

Long-term retention: Participation programs can strengthen your team's long-term commitment to your startup, as they can benefit from their involvement in the long term.

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Types of employee participation

A basic distinction is made between financial and nonfinancial forms of employee participation.

Nonfinancial employee participation aims to involve employees more closely in the company and its decisions by giving them more responsibility or taking their opinions more into account, e.g. through surveys and votes.

In the case of financial employee participation, the focus is on the remuneration that employees receive for their loyalty and commitment. This type of participation includes, for example: special payments for achieving certain targets, profit-sharing rights or shares in a limited liability company, and dormant holdings.

The popular participation programs ESOP and VSOP also fall under the category of financial employee participation. These participation programs are popular because they offer a fixed contractual framework. You can find out which conditions are defined in this framework agreement and what exactly ESOP and VSOP mean in the next chapter.

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ESOP

ESOP stands for Employee Stock Option Plan. It involves the issue of real company shares to employees as an incentive. These company shares are issued in the form of securities or GmbH shares.

The typical conditions for participating in an ESOP and receiving company shares are usually already defined in the employment contract with the employees. These conditions include:  

• When and under what conditions the option on the company shares is acquired. These can be agreed targets or milestones or depend on years of service.
• When the option can be exercised, i.e. when the company shares can be acquired by the employees. This process is also referred to as "vesting".
• Leaver provisions, i.e. what happens to the share options if the employee leaves the company under certain circumstances.
• And the information on the price of the shares and the maximum number of shares that can be acquired.

It is also important to note with ESOPs that employees become real shareholders and therefore also have voting rights, which can be a risk depending on the size of the investment.

In addition, there are tax risks for the employees ("dry income"), as they have to pay income tax on the shares they receive without having received liquid funds in return.

In addition, this form of employee share ownership requires notarization, which is associated with additional time and costs. Compared to the VSOP, the ESOP is therefore a less frequently used form of employee participation.

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VSOP

VSOP stands for Virtual Stock Option Plan and, like the ESOP, aims to allow employees to participate in the success of your startup through company shares.

However, they do not receive real company shares in the VSOP, but so-called phantom shares. Phantom shares are merely an agreement under the law of obligations that the entitled employees have a claim to payment from you as the founder as if they owned real shares in the company.

This arrangement eliminates the weaknesses of the ESOP, as no notarization is required and there is also no voting right. Furthermore, there is also no problem of "dry income". However, this form of employee participation has the disadvantage that only three conditions are usually defined that lead to a payout to the employee:

• Upon exit of the company, through the purchase of external investors.
• Upon resignation of the employee
• If there is a profit distribution to the real shareholders.

The alternative to ESOP and VSOP: the GmbH token

Tokenize.it enables start-ups to implement a completely new form of employee participation that has several advantages. We rely on the concept of GmbH tokens, which are used to incentivize your team.

GmbH tokens are digital units that are stored on a blockchain and are therefore unchangeable and uniquely assignable. These properties make them perfect for their field of application, namely representing completely digital participation rights in companies without notarization.

Technical functionality:

Before discussing the legal characteristics of GmbH tokens, the technical functionality should first be considered. As already mentioned, GmbH tokens are digital units that are generated ("minting") and stored on a blockchain. We use the Ethereum blockchain for this.

If you want to register on our platform, you first need to connect to a wallet "digital wallet". Don't worry, we also offer a simple Google login that automatically creates a wallet for you in the background. A wallet is necessary to manage the GmbH tokens on the blockchain.

As soon as this is done, you go through a registration process in which you enter your data and configure your GmbH token. After our verification and activation, you can use the employee participation tool in the dashboard. To do this, you set up vesting plans for your employees and share them with them digitally via a link. Your team can then also log in to our platform via the link, agree to the vesting plan you have prepared and sign the corresponding legal documents digitally.

All necessary legal documents are provided by us and only need to be personalized by you in a few steps.

The GmbH tokens are only created on the blockchain when they are "withdrawn" from the vesting plan by a team member. The tokens are automatically transferred to the wallet.

This is done by a so-called smart contract, a program stored on the blockchain. All smart contracts created by Tokenize.it are open source and have been checked for errors in special audits by external companies to increase security. The GmbH tokens are based on the ERC20 standard, making them compatible with all wallets in the Ethereum ecosystem. This allows them to be easily transferred between different wallets, which enables a secondary marketand thus better tradability.

How it works legally:

GmbH tokens represent participation rights in your company. They are therefore not genuine company shares, but put their holders economically on an equal footing with shareholders.

This economic equality is based on various rights that are granted to them.

Firstly, GmbH token holders have the right to participate in the economic success of your startup, which means they are entitled to exit proceeds, liquidity proceeds, and dividend distributions.

In addition, they have a right to information in the form of annual reporting. It should be noted that while they hold the GmbH tokens, they have no voting rights, as is the case with real company shares.

Another key element is the put option. This gives holders the opportunity to return their GmbH tokens to the company and be compensated for them. However, you as the startup founder decide for yourself in what form they are compensated. They can either receive the equivalent value of the GmbH tokens in the form of shares (if a conversion to the AG company form has taken place or will take place in the future), or you can pay them the value of the GmbH tokens at the current market price, or you can issue new GmbH shares in the company. This is also known as conversion.

The tokens and the associated rights are inextricably linked by the participation agreements provided by us and the promotion anchored in the BGB. All legal documents were prepared and reviewed in cooperation with legal experts.

Comparison between ESOP, VSOP, and GmbH tokens

To improve comparability, the following table compares the most important properties of ESOP, VSOP, and GmbH tokens.

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Complexity: A contract is required for all three forms of participation. In addition, the ESOP requires notarization, which is not necessary for the VSOP and the GmbH token. The GmbH token participation also has the complexity level of the digital token, which requires some knowledge in dealing with them. However, it also offers advantages, such as tradability on the secondary market.  

Taxes: Income tax is due on all three forms of participation, which can amount to 14-45% of the value depending on the tax bracket. In the case of ESOPs, the "dry income" problem already explained can be added here. In the case of GmbH tokens, there is also a withholding tax on the gain in value of the GmbH tokens when they are sold after minting.

Liquidity: With the ESOP and VSOP, the claim to the company shares or phantom shares cannot be traded. However, the GmbH token can be easily traded on the secondary market due to its legal structure and easy transferability.

Rights: With the ESOP, employees receive the same rights as shareholders from the time of exercise. The VSOP contract generally only enables exit proceeds. If the GmbH tokens are mined, i.e. created on the blockchain and transferred to the employees' wallet, they have the same rights as real shareholders and the put option.

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Sounds interesting?

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If you have further questions, you can send us a question using the contact form or read the documentation.