Background
Around the world, governments looking to develop a local startup ecosystem have enacted legislation implementing favourable tax treatment for equity and option plans.
Schemes like the UK's Enterprise Mangement Incentive (EMI) scheme have been introduced which aim to incentivise employees to take risks and join early stage companies where they may have to take a lower salary, but can be rewarded with a share of the company they help build.
The German government has unfortunately been (and remains) slow to implement meaningful tax change, which combined with the high administrative burden associated with real equity options, as well as ingrained expectations amongst founders and investors means that most (although not all) German startups choose to implement a "virtual stock option plan" ("VSOP").
What is a "virtual stock option"?
You might also see them described as "phantom stock options", and as both names indicate they are not "real" options.
Options give the holder (the "Option Holder") a right (or option) to buy shares in the company that issued them. The Option Holder exercises the option (says that they want to buy the shares) and the company has to issue the Option Holder the number of shares to which they are entitled.
Virtual/phantom stock options never result in the issuance of any new shares in the company. What they do is they entitle the holder to cash (and cash only) following a "Liquidity Event" (normally an IPO or a sale).
Why are they called options then?
The reason they are referred to as "virtual stock options" is because when there is a Liquidity Event and the "amount per share" that each shareholder of the company is entitled to is being calculated, they are included in the denominator with all the other outstanding shares in the company.
In other words, they are treated as if they are options/shares but only for the purposes of calculating payouts following a Liquidity Event.
To give a simplified example:
Company A is being sold for EUR 10m (after all transaction costs so this is the amount going to shareholders)
There are 1000 equity shares that have been issued to the founders and investors
Normally the founders and investors would get (EUR 10,000,000 / 1000) per share that they held. So a founder that held 250 of those shares ("Founder A") would receive ((10,000,000 / 1000) * 200) = EUR 2,000,000
However, there are 200 virtual options that have been issued to employees meaning that for the purposes of the calculation Company A is treated as having 1200 shares in issue
Founder A would therefore receive a lower amount ((10,000,000 / 1200) * 200) = EUR 1,666,666,67
How can LawSimple help?
If you are thinking about joining a startup in Germany and have been offered participation in a VSOP then you should know what it is that you are signing, what are the potential upsides and what are the downsides. You should also feel comfortable negotiating the terms rather than just accepting the first version you are given.
We have seen a lot of VSOP option plans. We know what they look like, what each clause means and what is market standard.
We will review your VSOP, explain any bits you don't understand and tell you where you can negotiate and where you can't. We charge a flat fee of EUR 300 and can turn around comments in < 24 hours.
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