Suitable ESOPs & VSOPs: entrepreneurs should consider this checklist before implementation

Since the passing of the Future Financing Act, the topic of employee participation has become increasingly important. Whether implementing ESOPs (real shares) or VSOPs (virtual shares), there are numerous aspects and options to consider when setting up a participation program. The following points are examples of some of the most common and important considerations that are critical on the road to a customized and effective equity program:

Objectives of employee participation programs - key factor for success

The objective of an employee participation program is closely linked to the type and development phase of the company. The main objectives are often to attract new employees, retain existing employees and motivate them. In addition, objectives such as strengthening the employer brand, transferring responsibility, promoting a sense of belonging or arrangements for company succession can also be important reasons for awarding shares to employees.

When drafting the necessary contracts, management should have a clear idea of the specific objectives to be achieved with the program. These objectives are crucial for answering important questions and thus for designing an ideal and suitable employee participation program.

Allocation of shares in companies: From key personnel to broad employee participation

The decision as to who within the company should receive shares is a central and complex issue that is closely linked to the HR strategy and corporate philosophy. It is important to consider whether only selected individuals, all managers, certain management levels or all employees of the company should receive shares. Although the decision and allocation can be adjusted during the business cycle, careful planning at the outset is of great benefit. Although the allocation is a matter of negotiation with the beneficiaries, a systematic approach ensures an efficient and fair distribution.

A typical system could therefore look like this:

• The early involvement of the first employees, who accept salary losses and personal risks in the initial phase of the start-up
• The involvement of individual key figures such as the CTO, the head of technology or the head of sales
• The involvement of managers from certain hierarchical levels, such as C-level or Head Of
• The general participation of all full-time employees The allocation of shares to (later) co-founders

Determination of the share amount - strategies for fair determination

Deciding on the exact amount of shares for individual beneficiaries is one of the most frequent and controversial questions, especially in connection with determining the strike price. Unfortunately, there is no universal answer here, as this depends heavily on factors such as the type of company or strategy as well as the situation and size of the company.

The distribution of shares should be fair and take into account aspects such as the respective contribution to value creation, responsibility and risk appetite of the beneficiaries. Various questions should be considered in order to determine an appropriate level of shares:

• How many shares are currently to be issued in total?
• What is the planned size of the company and thus the group of beneficiaries?
• How many more shares are to be awarded in the future?
• Do employees who leave the company keep their shares or are they redistributed?

The total remuneration and the opportunity costs of the respective beneficiaries also play a role.

Although there is no clear answer, the shares in early company phases often range between 0.1 percent and 5 percent. In later phases, however, shares of less than 0.01% are not uncommon. Depending on the company value determined by the last financing round and the associated higher base price of the shares, these can already represent a considerable value.

Base price as the linchpin of employee participation programs

As already discussed, the strike price plays a decisive role and is often even more important than the number of shares themselves.

Put simply, the strike price represents the assumed value of the shares at the time they are allocated. In the case of virtual shares, so-called VSOPs, this strike price can theoretically be freely determined, which increases its importance enormously, as it has a significant influence on the subsequent financial return for the beneficiaries.

In common models, the difference between the base price and the sales price is paid out to the beneficiaries on a pro rata basis. Employees who participate early often receive a base price of one euro per share, while employees who join later, at a time when the company already has a certain value, often receive shares at a higher base price. This means that their potential financial return is lower, as they only receive the difference between the base price and the sale price of the shares in the event of an exit.

A simplified example to illustrate this:An employee who receives 1000 shares at a base price of one euro per share when the company is founded, and the buyer of the company receives 200 euros per share on exit. The employee therefore receives the difference to the base value, i.e. the sales value less the base price: (1000 * € 200) - (1000 * € 1) = € 199,000.An employee who joins the company later and also receives 1000 shares, but at a base price of € 50 per share, receives € 150,000 on exit: (1000 * € 200) - (1000 * € 50) = € 150,000.

Vesting and cliff: time frame for employee shareholdings

The vesting period determines the length of time a beneficiary must work for the company for their shares to vest. This period should be aligned with both the company's strategy and the individual situation of the beneficiary. It is typically between two and five years.

The so-called cliff is a type of waiting period that specifies the minimum length of time a beneficiary must remain with the company in order to be able to assert claims from the shares accumulated during the cliff period for the first time.

An example to illustrate this: an employee who holds three percent shares with linear vesting over three years and a cliff of one year leaves the company before the end of the one-year vesting period (cliff). In this case, he would not receive any shares.

Development of legally compliant employee participation programs - Clarification of further critical issues

The main objective of a legally sound employee participation program is to consider all conceivable scenarios and to regulate them in advance in order to prevent misunderstandings, room for interpretation or costly legal disputes. Numerous relevant questions must therefore be clarified for the tailor-made design of the program. Some of the key questions that address such scenarios include

What happens if an employee with shares leaves the company? how is the case of a company sale (exit) defined? is there a provision for accelerated vesting, i.e. an accelerated schedule according to which employees receive their shares? how is the participation program communicated to employees?

It is crucial to understand that there is no universally perfect employee participation program, but an ideally adapted program can be developed for each company in its specific phase. Adequately answering these and similar questions and designing the program accordingly will maximize its benefits. An effective program is one that is tailored to the individual goals and needs of the company. Unclear questions and imprecise wording, on the other hand, create room for interpretation and potential litigation, which must be avoided at all costs.

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