#ESOPasap: How Better Conditions for Employee Ownership Promote Innovation and Growth

A new report from BCGDV, BCG, the German Startup Association, the Internet Economy Foundation, and Hengeler Mueller identifies the problems with employee ownership in the startup economy — and suggests a way forward.

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A staple of the startup and technology environment in the U.S. and elsewhere, schemes for employee share ownership and equity are less prevalent in Germany.

With this in mind, The Federal Association of German Startups (Startup Association), the Boston Consulting Group (BCG), BCG Digital Ventures, the Internet Economy Foundation (IE.F), and the law firm Hengeler Mueller put together a study to understand the reality of the situation.

The study provides a comprehensive picture of the diverse challenges start-ups face when dealing with employee share ownership. These are mainly due to the currently inadequate legal framework conditions, which prevent the broad and effective participation of employees. This puts the German technology economy in a difficult position. The study draws on the results of an exclusive online survey with over 1900 participants from the startup ecosystem and almost 70 interviews with experts.

Download the Study (German only) Here

Here are some of the report’s key findings:

  1. Employee participation schemes are essential for a successful startup ecosystem
    For 84% of those surveyed, employee share ownership schemes are essential for the success of startups.
  2. Employee participation schemes ensure recognition and identification
    For 77% of the employees surveyed, employee participation meant recognition of personal performance, while 66% see it as a sign of strong identification with the startup and its goals. 59% regard employee participation as financial compensation.
  3. Proceeds from employee shareholdings enable a self-firing startup ecosystem
    38% of all respondents had used proceeds from previous employee share ownership schemes either to establish their own startups or to invest in existing startups.
  4. The general conditions in Germany are not internationally competitive
    Only 3% believed that the general conditions for employee participation in Germany are better than in other EU countries. 49% of those surveyed believed that the framework conditions for employee financial participation in Germany are significantly worse than in other EU countries (the remaining 48% could not provide their insights on this question).
  5. Poor framework conditions have fatal consequences for startups
    37% of employees surveyed would consider moving to an established company and 26% would consider moving to a startup abroad, provided the general conditions remained the same. 23% of founders surveyed said they have delayed or canceled investments in Germany due to the general conditions, and 18% even agreed with the statement that they plan to move the headquarters of their startup abroad in order to attract talent.

While the current situation for startups in Germany in the context of employee ownership and participation has some serious shortcomings, this doesn’t have to be the case. The study provides four concrete recommendations for decisively improving conditions and making Germany one of the world’s most attractive ecosystems for both innovation and employee ownership.

  1. Creation of a separate share class
    A separate class of shares should be created in GmbH law, specifically tailored to the needs of employee participation schemes in order to enable employees to participate in a GmbH in a practical way as shareholders. It must be possible to issue and transfer such employee shares inexpensively, quickly, easily and digitally, and they should have information and participation rights appropriate to primarily asset-based participation.
  2. Fair Taxation
    According to the international model, employees should only have to pay tax on a non-cash benefit from the shares granted to them when they actually receive liquid funds from the shares (i.e. only after a sale). Since this is not regular pay, but rather proceeds from employee shareholding, the non-cash benefits from employee share ownership programs should be taxed uniformly as investment income.
  3. Allowances for reinvestment
    Reinvestment of proceeds from employee share ownership schemes in German startups should be encouraged in order to enable a self-firing startup ecosystem. Proceeds from employee participation schemes should therefore be tax-free, provided that employees reinvest these funds in the startup ecosystem, for example as founders or investors.
  4. Creating a transparent evaluation process
    Currently, it is difficult to evaluate a startup for tax purposes. For employees, this leads to incalculable risks in the granting and transfer of employee shares due to high tax demands based on unforeseeable valuations. In order to effectively reduce these risks, neutral, simple and inexpensive evaluation procedures for startups and employee shares should be introduced, following the international model.

Speaking about the study and what can be done to improve the conditions for employee stock ownership in Germany, BCGDV Global Managing Partner said: “Employee stock option programs in startups are an absolute international standard. It’s not just employees and companies that benefit, but the entire ecosystem. Even for established companies, the innovative power of agile startups brings advantages, as they develop innovative technologies to market maturity. The poor framework conditions for employee participation in Germany make it difficult for the German startup ecosystem and thus the entire German economy to develop successfully.”

You can read the full study (in German only) here.

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BCG Digital Ventures, part of BCG X, builds and scales innovative businesses with the world’s most influential companies.