The key differences: ESOP vs. VSOP - real and virtual employee stock options

Employee shareholdings, especially in start-ups, aim to give employees a direct stake in the success and growth of the company instead of paying them a high salary. In addition, such shareholdings give employees real voting rights and allow them to significantly influence entrepreneurial decisions. However, real shareholdings, so-called ESOPs, are associated with a considerable administrative effort - you save this with virtual shareholdings, so-called VSOPs.

ESOP: What is true employee ownership?

The Employee Stock Option Plan (ESOP) refers to a "genuine employee shareholding". This means that the employee acquires shares in the company's capital stock or share capital by complying with company and civil law regulations. In the case of the GmbH, the share capital is approximately at least 25,000 euros; of this sum, the employee could receive up to five percent under an ESOP, for example.

The classic ESOP agreement regulates what percentage of the capital stock can be acquired when and under what conditions. To this end, the agreement distinguishes between two significant dates and periods: 

• Cliff time: Only when the employee has reached the so-called cliff does he or she receive a corresponding option at all. This is, for example, one year; if the employee leaves the company before this time, he has no entitlement to the acquisition of shares.
• Vesting period: This specifies the (further) points in time at which the employee receives additional options. For example, it can be agreed that after the first year the employee is entitled to one percent of the share capital and that in each of the following four years the employee is entitled to a further one percent. In total, the employee could thus have a maximum shareholding of five percent in the company.

A variety of deviations from the "norm" are conceivable within the scope of contractual freedom. For example, the employer and employee can agree that the exercise of the option depends on the reasons(good leaver vs. bad leaver) for the termination of the employment contract. If, for example, the employment contract is terminated for good cause, the employee has not proven to be "worthy" of the shares - and has therefore forfeited their option.

Advantages of the ESOP agreement for employer and employee

With an ESOP, both employer and employee benefit from several advantages: 

• Direct participation in the Company's success, either with or without the achievement of specific targets (such as sales or turnover figures)
• Long- or medium-term commitment of the employee to the company through the prospect of being able to acquire further (profitable) shares
• Saving of high salary expenses for qualified management and labor, especially in the formation phase of start-ups; strengthening of liquidity
• The employee does not have any direct voting rights; he or she acquires these only when the option is exercised and the associated "real shareholder status" is attained.

However, ESOP contracts also entail disadvantages. These include, in particular, dry income taxation, as the employee must pay tax on the option received as a non-cash benefit in accordance with Section 8 (2) EStG. At the same time, however, he lacks the necessary liquidity, as he could only achieve this by selling the shares. With Section 19a of the German Income Tax Act (EStG), the legislator has partially remedied this situation, but the standard only applies for a limited period and up to clearly defined company sizes.

Virtual employee stock ownership plans (VSOPs) as an alternative to real participation

Under ESOP agreements, notary appointments are regularly required to have the share transfers notarized accordingly. In addition, the administration is comparatively costly due to legal requirements, and the employee also receives voting rights and all other shareholder rights. As an employer, this also partially restricts your entrepreneurial decision-making freedom.

A good alternative is therefore virtual employee stock ownership plans (VSOPs). They also include a cliff and vesting period, but differ from the ESOP in that the employee does not acquire an actual share in the company's capital stock or share capital. He is merely placed in the same financial position as if he were a shareholder in the corporation.

A virtual shareholding of four percent therefore secures the employee four percent of the profit distributions and (taking into account the underlying value of his virtual shares) up to four percent of any sale proceeds, but he does not acquire any voting rights. The real shares remain in the assets of the previous shareholders.

Payments based on a VSOP are business expenses for the employer (Section 4 (4) EStG) and wages for the employee (Section 19 (1) no. 1 EStG).

Compared to the ESOP, the VSOP is more flexible and thus also brings various advantages for employers and employees:

• Benefits of the ESOP such as strengthening employee loyalty and the "we" feeling
• No notarial agreement necessary, processes under company law are completely eliminated
• No change in the Company's shareholding structure, employees do not receive any voting rights
• Preservation of liquidity especially in the initial phase of the company
• VSOP reduces salary expense as lower compensation is offset

ESOP or VSOP - which ultimately suits the company better?

At this point, we could certainly write an entire novel about the individual advantages and disadvantages of the respective form of participation. In the end, the decision always depends on the individual case.

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Disclaimer: The contents of the information offered at esop-direkt.de do not constitute legal advice. If you require a legal review of your individual case, please contact our specialized team: beratung@esop-direkt.de