Giving shares to your early employees is a well-established practice among US start-ups, where it’s almost a standard part of the compensation package. Belgian start-ups, on the other hand, are doing less and that while shares are a great opportunity to involve your early employees. That is why, together with our legal partner Loyens & Loeff, we looked into how this can be done within the Belgian legal framework.
Do you know Taavet Hinrikus? The name probably doesn’t ring a bell, but the start-up he co-founded might: TransferWise. The original Estonian company is now based in London, where they make payments cheaper across borders. They already raised over $480 million in capital and in 2018, 4 million people used their service.
But TransferWise was not the first company Hinrikus helped to grow. He was one of the first employees of Skype, where he learned the craft and crucially, received a large sum of money. This allowed him to sell his shares when Microsoft acquired the video chat service in 2011.
Strength of shares
Hinrikus’ story shows one of the reasons why giving shares to early employees can be so important. When a start-up realises an exit, either through a takeover or an IPO, early stage employees can suddenly earn big money with shares. They then often use that capital to invest in other start-ups, or to set up their own company.
It also has advantages for the start-up itself. For example, young companies often need talent, but cannot compete with large corporates on compensation. With shares, on the other hand, employees have the chance to receive large payouts if the start-up proves to be truly successful. It also gives those employees an incentive to really make an effort for the company. So everyone, founders and employees alike, are in the same boat.
But despite the advantages, Belgian start-ups make less use of this type of scheme. And there’s a reason for that, of course. Whereas in the US and the UK this is a fully established practice (with advantageous tax regulations and standard contracts), this is not yet the case in Belgium (and many neighbouring countries). Nevertheless, it is not impossible for a Belgian start-up to issue shares.
Step 1: Think before you begin
A first step is to plan everything thoroughly. Usually start-ups choose to
set up. All conditions are central to this and are the same for everyone. Individual arrangements around shares are of course also a possibility, but that increases the administrative burden on the side of the start-up.
Look before you leap, because the administration is difficult and issuing shares has consequences for your company. Consult with legal and tax experts, especially when operating in several countries.
For example, such a plan is important because it can affect your future growth if not fully thought out. For example, when:
- you’re doing an investment round. There, employee shares can influence the final deal. So make sure you plan out in advance how employee shares will fit into your growth plan. Often start-ups only set up an equity plan when, for example, professional investors also come on board.
- you’re internationalizing. There it may be more difficult to include your foreign workers in such a plan. You have to take into account local rules on taxation and employee protection.
- to pay out your shares. Depending on the liquidity of the awarded shares, you will have to pay them out and at that point your cash flow should be able to handle that. This can quickly add up, especially in the case of phantom shares or stock appreciation rights (see below).
Step 2: choose your option
In Belgium, there are various ways of granting stock options to employees. The three most commonly used categories of these are:
- stock options. You give employees the opportunity to buy existing shares at the current – hopefully lower – price on the (future) exercise date. In such a plan, one (or more) existing shareholder(s) will have to sell shares when the options are exercised, causing dilution for this/these party(ies).
- warrants. These are a type of security and in some ways similar to stock options. In essence, after a set period, you get the chance to buy newly issued shares at the current – hopefully lower – price. Because these are new shares, the dilution that occurs will be borne equally by all shareholders.
- phantom shares of stock appreciation rights. No real shares are passed around here. The company simply gives a cash bonus after a set period in proportion to how the price of the shares rose in the intervening period, in other words, the more successful the company, the higher the bonus.
Every way has its drawbacks, of course. For example, with an option or a warrant, the price of the shares must be determined by an auditor and the employee must immediately pay taxes on this value if they want to enjoy favourable tax conditions.
Phantom shares or stock appreciation rights fall under the regulation for ordinary remuneration. The employee will have to pay a relatively high tax rate on professional income which can be as high as 50%. Also, that cash bonus sometimes proves difficult for startups, because a sudden rise in the stock price can lead to a large payout to your employees.
Step 3: choose the right moment
Such a plan is also best set up at the right time. In countries such as the US and the UK, where legal regimes are more relaxed, start-ups often give shares to their very first employees.
In Belgium, due to the high administrative burden of the tax regime (such as paying taxes on issuance and not on exercise), it is often better to save shares for later rounds. Think of a round A, B or even C. At that point, the growth trajectory of a company is already better understood, there are more resources to absorb the legal costs and employees know better what they will earn.
Moreover, venture capitalists or other professional investors often have a good idea about how they wish to incentivise employees and this does not always correspond to how founders saw it in the early stages of their start-up. So waiting a while can be useful.
Step 4: make a choice
For larger start-ups, issuing shares can be a good choice. This way you better involve employees in your company and it is an extra persuasion to come and work for your start-up.
Therefore, even in Belgium, issuing shares can be a good tool in the toolbox of start-ups. Be careful of course, and get good advice from experts. But certainly don’t let the administration put you off. Because maybe your early employees will become the start-up founders of the future.
Looking for more information? Be sure to read the articles below:
- WIRED: Has Skype lost its way? Taavet Hinrikus reveals what the company taught him
- Loyens & Loeff: Tax regime for stock options in Belgium
- Wolters Kluwer: Stock options: what about it?
- De Tijd: How to benefit from your employer’s growth