Models for employee participation in start-ups
When it comes to employee participation in start-ups, two terms keep popping up: ESOP and VSOP. In the following I would like to take a look at these two terms and report from practice under which circumstances these models make sense.
Contents
Employee participation: What kind of participation should it be?
Before I talk about ESOP and VSOP in detail, I would like to allow two small preliminary considerations that founders should also make. On the one hand, there is the question of what exactly these two “SOPs” stand for. On the other hand, there is the question of what consequences should arise from participation.
This is important because, depending on the type of participation, certain rights and possibly also obligations arise with it. Regarding the first question, it is again important to understand that an “SOP” stands for “Stock Option Plan”. It is therefore a model according to which employees receive shares in a start-up under certain conditions.
As a rule, these shares are not transferred immediately, with the result that the status of a shareholder is obtained immediately, but there are certain prerequisites that lead to a position as a shareholder after a certain period of time.
With regard to the second question, on the one hand a “classic” participation can arise in such a way that employees take part in shareholders’ meetings and have a say in decisions, but also have a share in the company’s profits.
On the other hand, it can also only be about enabling certain monetary consequences for the employees without them directly entering into the position of a shareholder. This is done when the employees are not supposed to have a say in decisions, for example.
This keeps the circle of shareholders, the “cap table” manageable, which is regularly important for investors. These preliminary considerations now lead to being able to select the appropriate participation models.
If, during the preliminary considerations, you come to the conclusion that employees should become shareholders, then an ESOP can be the right model. ESOP stands for “Employee Stock Option Plan” and describes a model according to which employees can acquire real shares in the start-up under certain conditions.
This makes them real shareholders with the corresponding rights and obligations that result from being a shareholder. It is therefore crucial in an ESOP that the conditions are clearly defined. These can relate, for example, to certain target values that must be achieved.
These can be financial variables such as net income or EBITDA, but also, for example, the value of equity or the valuation as part of a financing round. However, the conditions can also relate, for example, to the duration of employment in a company.
Vesting clauses and lockup as usual conditions
In addition, it is also common to include vesting clauses or lock-up periods as conditions regarding the payment of monies resulting from an investment. And of course it is necessary to regulate which share and at what price employees can acquire.
As already mentioned, an ESOP leads to employees gaining real shareholder status under certain conditions. However, an ESOP regularly requires a complex set of contracts that should be comprehensible, simple and long-term.
If you don’t really want or need that, and in particular obtaining a position as a shareholder is not a priority, then founders should take a look at the so-called VSOP.
A VSOP leads to monetary rights
In contrast to an ESOP, a VSOP is a participation model that does not involve real but virtual shares in a start-up. VSOP therefore stands for “Virtual Stock Option Plan”. This is a contractual relationship between the company and the employee.
This requires a corresponding contract between both parties. And because it is not about real shares, no notarial participation is required for this contract, which reduces costs. In practice, this model always leads to faulty reasoning, which is why I would like to emphasize it again:
In a VSOP, founders must distinguish between real and virtual participation in the company. The employees who are “involved” via a VSOP are not actually involved in the company. The participation is only fictitious, i.e. intended to be able to regulate certain consequences.
So only those who are entered as shareholders in the commercial register are really involved in the start-up. Interests through a VSOP do not result in such an entry. So what’s the point of a VSOP? It makes it possible to give employees certain benefits.
VOSP: The financial benefits for employees
These can be of a monetary, i.e. financial nature in particular, without expanding the group of shareholders. This usually involves a share in the proceeds from the sale of the company, but sometimes also in the annual profit distributions.
A VSOP also usually comes with conditions, such as a lower limit on sale, rules on the stake and the exercise price, as well as dilution rules for capital increases and rules on the lockup period.
A VSOP is suitable as a participation model when a manageable model is required that relates to financial aspects and is not intended to expand the group of shareholders.
However, one should keep in mind that a VSOP as a participation model does not fulfill its purpose if, for example, the start-up is not sold or if there is no annual profit. Because then the participation promised via the VSOP becomes worthless.
Conclusion: Models for employee participation in start-ups
With this article I would like to present the basic considerations that should be in the foreground with an ESOP or a VSOP and show how these models can be used. I am aware that this article leaves many practical questions unanswered, for example those of a tax nature.
In practice, however, I experience in discussions with founders that there are often many misunderstandings and uncertainties with regard to the possible applications and the distinction between ESOP and VSOP. I hope I was able to shed some light on this.
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