Improving investment in Dutch startups? Let’s fix our tax laws first

A shortened Dutch version of the following op-ed was published in Financieel Dagblad. It was signed by Operator Exchange community members and Leo Brand, Godfried Kinnegim, Marike van Lier Lels, Michiel Muller, Constantijn van Oranje-Nassau, Alexander Rinnooy Kan, René Steenvoorden and Jeroen van der Veer.

The Netherlands has the talent and infrastructure to be the number one startup ecosystem in Europe. However, we may not win in the long run due to the way we regulate investment. By changing our laws in three specific ways we think we can help founders and investors, increase the amount of funding available, and continue to accelerate job growth.

Not yet at the top

Dutch startups generated over €44 billion in economic value and added over 19700 jobs to the economy. Startups such as Adyen, Mollie, Picnic, Coolblue, and Messagebird are great examples of homegrown successes.

However, we still perform poorly compared to the rest of Europe, let alone the rest of the world as is apparent from the 2020 Global Startup Ecosystem Rankings van Startup Genome. The total annual investment of €1.1 billion doesn’t stand up against the €10.4 in the United Kingdom or the €45 billion in Silicon Valley.

Closing the invest, build, exit loop

To build a successful ecosystem you want to accelerate the invest, build, exit loop. This starts with networks of great angel investors and Venture Capitalists that invest in early-stage companies. These companies grow and attract more (local) investment. Once the company becomes a success and is ready to be sold or listed as a public company, the founders and first couple of hundred employees reap the benefits. They go on to start new companies and fund new founders. This ultimately creates a loop leading to more investment and more knowledgeable founders and (angel) investors. It’s also a major driver for high-quality employment. These ecosystems are often super local, and it’s the same reason why 50% of the S&P500 index consists of tech companies (Apple, Amazon, Alphabet, Microsoft & Facebook) that were founded in approximately the same postal code area in Silicon Valley and Seattle.

Too often money invested in Dutch startups is not coming from local investors or angels. Over 40% of investment in Dutch startups is coming from the United States. And almost all of the Dutch unicorns have majority investors from abroad. This breaks the local invest, build, exit loop, and limits the acceleration of the Dutch startup ecosystem.

Fixing employee participation, deductions, and re-investment

We propose three changes we believe can fix our broken invest, build, exit loop.

1. Employee Participation: As a starting company you don’t have the money to pay top salaries, but you need access to the top talent in order to be successful. The way founders solve this is by giving a relatively low base salary with ownership in the company through stock options. If the company fairs well, the (early) employees fair well as their stock option value grows dramatically. Current Dutch laws disincentive this type of compensation, and even add additional risk for employees. In principle, we tax employees at the moment their stock is granted to them, instead of when the stock becomes tradable. And we tax stock options when these are exercised, instead of when the stock acquired upon exercise has become tradeable. This means that you get a big fat tax bill on a valuation that is not certain to materialize before you can turn any of your stock options into cash. This has two downside risks for the employee. First, they need to spend a lot in taxes sometimes years before a company goes public or gets sold. And if that weren’t enough, if it turns out a company was incorrectly valued and does ultimately not succeed, you cannot get your money back from the tax authorities adding even more risk to an already risky venture.
2. Reinvestment: Founders, angels, and investors generally don’t stop after they have been successful. In the Paying it Forward mentality of Silicon Valley you are expected to help out the next generation with your knowledge, network, and money. In the United Kingdom (Enterprise Investment Scheme) and the United States (Qualified Small Business Stock Exemption), they specifically encourage re-investing the gains of previous success through their tax laws. Gains from a qualifying startup investment are not directly taxed but can be extended if an investor decides to reinvest their gains in the next startup. This could be organized by allowing for a roll-over for professional investors and employees that cannot apply for the Dutch participation exemption, adding a deduction to Box III for tech-related investment (similar to the green investment deduction that currently exists) and for private investors allowing for deductions of losses on high-risk startup investments.
3. Deductions: most of the deductions that are currently available to companies focus on lowering tax on profits. However, most tech startups (deliberately) don’t have profits as they are investing in building and growing their business using venture money. So deducting profits from your tax bill doesn’t really help you at all. Deductions that are aimed at increasing economic activity should be aimed towards income and value-added tax in order to be meaningful to startups. We propose to introduce a Tech Related Deductible (tech gerelateerde impact korting — TIK) where qualifying startups that are building and growing their product can lower their monthly tax bill by deducting income and value-added tax. These deductions could be paid back once the company is successful years later.

We think that with these regulatory changes we can leap ahead and build the next generation of Dutch unicorns.

More to come

Our community at Operator Exchange understands the day to day of starting a company in the Netherlands very well, but we’re not legal experts. We’re grateful for the help from Allen & Overy in preparing these proposals. You can read a more fleshed-out version of the ideas described above on their blog (in Dutch).

This partnership is just getting started. We’re actively working with Allen & Overy to publish a white-paper for policymakers on how to improve the Dutch legal and tax framework for startups. Together, we’re also building a set of free, simple, and proven agreements to get that first money into the company. Think SAFE financing documents, but for Dutch law. Stay tuned!