The GEN Atlas Policy Deep Dive explores several examples similar policies introduced in different countries. By drawing out the subtle variations in approach and highlighting innovative ideas, we hope to learn more about the most effective approaches to policy making and offer a roadmap for other policymakers to learn from. Our analysis of startup support policy is built around eight overarching themes:
- Finance: New types of capital for startups and scaleups at the right time
- Education + Skills: Embedding enterprise and entrepreneurship into education and providing (both existing and potential) entrepreneurs with mentoring, training and support
- Market Access: Expanding access to markets for startups domestically and abroad
- Inclusivity + Culture: Ensuring that entrepreneurship is a culturally attractive vocation for all sections of society and in particular that people from disadvantaged groups have an equal opportunity to launch and grow a business
- Regulation: Removing regulatory barriers to innovation and startup success
- Ecosystem + Economic Development: Developing and managing local ecosystems to better support entrepreneurs, startups and scale-ups
- Science, Technology and Innovation: Utilizing the latest advancements in science and technology to improve productivity, boost economic growth and solve societal problems through innovation
- Policy Making: Maintaining a data-driven, effective and coherent policy making process that supports entrepreneurs and ensures public awareness of available programs
Balancing the need for hiring the brightest and best with sound management of limited financial resources remains one of the most significant challenges that startups have to grapple with. Step forward employee share schemes.
The popularization of employee share schemes – commonly described as stock options – has been led by the United States and their historical roots can be traced back to the 1950s where they were used as a shelter from post war income taxes that reached as high as 91 percent. However, as income taxes fell, the popularity of stock options only continued to rise eventually becoming an integral part of the Silicon Valley dream with early employees of successful startups such as Google being transformed into millionaires.
The idea has spread around the world with countries competing to provide the most generous regulatory environment for companies to offer share schemes to existing and potential employees. Just last November, Germany became the latest country to join the club through the passing of the Future Financing Act. This has been a cause for huge celebration amongst the German startup community with the country long lagging behind its international counterparts.
To understand the popularity of share schemes it’s important to be clear about exactly what it is they do. Although programs vary – as we will come to shortly – the essence of the concept is that companies offer employees shares of stock as part of their compensation package to increase the attractiveness of employment without the immediate costs of a higher salary.
These offers are attractive to employees for two main reasons: firstly, there is the potential for high returns if the company’s stock price rises above the discounted value that the employee agreed to purchase them for; and secondly the sale of stock options are generally taxed at a significantly lower rate than standard income. Employee share schemes are also widely believed to align the interests of employees with those of the company and shareholders as they are to benefit directly from the success of the company as well as increasing employee retention rates. There are several broad categories of shares schemes to be aware of:
- Qualified Stock Options
The most famous type of share scheme are Stock Options and they have become almost synonymous with the concept. This type of scheme grants employees the right, but not the obligation, to purchase company stock at a predetermined price after a specified vesting period. Incentive Stock Options (ISOs) in the United States are one of the most well-known share schemes of this variety. Employers offer these options selectively to top-tier management and key employees. The ISOs have a predetermined schedule that includes a vesting period, which is the period during which the employee earns the right to exercise the options. The tax implications of ISOs are one of their major advantages. ISOs aren't taxed when they are granted, upon vesting, or even when exercised rather they deferred until the shares are sold.
While some countries share schemes have developed organically over time, others have been crafted deliberately by policymakers. One such example is the UK where there are several government backed programs. The most commonly used is the Enterprise Management Incentive (EMI) which allows companies to grant share options up to the value of £250,000 in a 3-year period. The recipient will not have to pay Income Tax or National Insurance if they buy these shares for at least the market value they had when the option was granted. Capital Gains Tax (CGT) is applied at a lower rate of 10% versus the standard 20% provided that the shares are not sold within 24 months of the option grant.
- Restricted Stock Unit (RSU)
RSUs are issued through a vesting plan and distribution schedule which means that they are contingent upon the employee meeting certain performance milestones or remaining with their employer for a particular length of time. Unlike Stock Options, RSUs provide a guaranteed value to the employee as part of the agreement meaning there is both less risk and less potential for reward with this type of plan. The BSPCE scheme in France is a notable RSU which provides employees with a reduced flat tax treatment of 30% on any gain accrued from stocks acquired through the program. The Share Incentive Plan (SIP) in the UK also uses this model, allowing companies to award individuals up to £3,600 worth of shares annually which avoid all forms of income tax provided they are kept in the plan for 5 years.
- Save As You Earn
A Save As You Earn (SAYE) scheme, also known as a Share Save scheme or a Savings-Related Share Option Scheme, is a type of employee benefit scheme used in the UK and Ireland. This scheme allows employees to save a fixed amount of money from their after-tax salary over a set period, typically 3 to 5 years. At the end of this savings period, employees are given the option to purchase shares in their employer at a price that was fixed at the start of the scheme (usually at a discount to the market value at the time the scheme started). In the UK employees can save between £5 and £500 per month, and at the end of the savings contract, they can either buy the shares with a discount of up to 20% of the market value, transfer them to a pension or ISA, or receive their savings back as a lump sum.
- Phantom shares & Non-Qualified Stock Options
In countries where governments have been slow to legislate for the use of tax advantaged share schemes, companies have often found a work around known as Phantom Shares or Virtual Shares. They are not real shares of stock, but rather a contractual agreement that provides a cash or equity bonus based on the value of the company's stock, mimicking the economic benefits of actual shares. While Phantom Shares have the benefit of flexibility, they can still lead to complicated tax liability depending on the jurisdiction. In Spain – where Phantom Shares have traditionally been the most commonly used form of share scheme – they are taxed as if they are a bonus which leads to a much higher level of taxation with Qualified Stock Options or RSUs.
Even in countries with more generous schemes, there can often be a benefit to companies using more flexible schemes that lack preferential tax treatment. Non-Qualified Stock Options (NSOs) remain popular in the United States due to the lack of stringent legal requirements attached to them and the simplicity of administration. The downside for the recipient is that they have to pay tax both at the point of exercise and the point of sale.
- Favorable tax systems
It is worth noting that some countries simply do not need to design top-down share schemes as their tax system is so advantageous in the first place. Instead, they allow companies the flexibility to create tailored programs that best suit their individual needs. One such example is Latvia – which has been crowned as having the most favorable stock option treatment in the world – where legislation was passed in 2020 that sets tax at just 20% for gains made on share schemes and also allows for a vesting period of just 12 months. Likewise, in Bahrain individuals are typically not taxed by the state so all that was required was for the concept of share schemes to be legalized.
What is best practice internationally?
The organization Not Optional has ranked each European country as well as Australia, Canada, Israel and US according to the attractiveness of the stock options available in their jurisdiction based on six key factors including; plan scope, strike price, bureaucracy, tax timing, employee taxation and employer taxation. Policymakers seeking to create a better environment for startups to attract talent should consider:
- Creating a program that is open to as many startups and employees as possible
- Ensuring that their tax treatment is international competitive and deferred to the point of sale
- Allowing startups to issue stock options with no voting rights to protect the ownership of startups and reduce the burden of consulting large numbers of minority shareholders
- Removing any uncertainty around the taxation of shares including the removal of corporate taxes
- Allowing startups to be flexible in the conditions they set for the sale of shares including how long the employees must wait to exit the scheme and how the shares are valued upon exit.
What measurable impact of share schemes is there?
While the benefits of share schemes for startups in terms of employee attraction, retention, and the aligning of interests may seem intuitively obvious, there is generally a lack of concrete evidence provided by governments for the impact of their tax advantaged programs. The country that bucks the trend in this regard is the UK which has provided full impact assessments for EMI, SIP and CSOP. These assessments provide participation figures, cost to taxpayer in terms of lost tax revenue, value of options granted, value of options exercised, and survey data from companies that use the schemes. Crucially the assessments found that both SIP and CSOP had a positive impact on company turnover, likewise, EMI was shown increase the number of employees at a participating company by 26 per cent over three years.
One crucial factor that is hard to pin down is the impact of cultural mindset on the success of a scheme. For example, the Key Employee Engagement Programme (KEEP) in Ireland was introduced in 2017 with the expectation that it would benefit participants by a collective €10 million per year, however, the figure had only reached €600,000 by 2021 due to significantly lower than expected participation. Likewise, analysis by sifted.eu found that despite looser rules in France and other European countries there remained a persistent cultural preference for salary increases over stock options.
Despite these issues, share schemes remain a potent – and in many cases underutilized – tool at the disposal of policymakers looking to give startups in their ecosystems a boost. The challenges presented by cultural resistance reaffirms the importance for the startup community in communicating the substantial benefits of share schemes to employees as well as policymakers.