Five forms of employee participation
Entrepreneurs know how vital it is to attract and retain key talent. They also know: it’s not easy. Key talent doesn’t settle for a ‘simple’ salary.
We advise a lot of clients on setting up employee participation schemes, allowing employees to feel involved and share in the success of the company. Our clients are growth companies, looking for employees who feel like co-entrepreneurs. Growth companies can’t compete with full grown corporates on the base salary and are forced into more creative ways of remunerating their team.
In this document, we give an overview of five legal structures for entrepreneurs to attract and retain key talent in the Netherlands.
Before we dive into legal details, a preliminary question. How do you actually motivate people? To answer that question, we should distinguish intrinsic and extrinsic motivation. With intrinsic motivation, it’s about the game. With extrinsic motivation it’s about the money. Both are important. But which motivation has the biggest impact? Historically, a lot of emphasis has been put on the money (extrinsic motivation). However, recent research shows that the game (intrinsic motivation) is also important. Maybe even more important.Is an extra financial reward even the way to attract and bind talent? Dan Pink explains in his TEDx Talk “The Puzzle of Motivation” that it doesn’t revolve around money. Our own clients also emphasize the importance of intrinsic motivation. De Correspondent for example, recently published this article of Rutger Bregman. And for a few decades now, our client the Brazilian Ricardo Semler has been describing how to intrinsically motivate your employees. According to Semler and Bregman involvement and responsibility are a much stronger motivator.The point we’re making: think carefully about which problem you want to solve within your company. And consider carefully if an extra financial reward is the solution. Perhaps you can reach the same goal with personal development programs, an air hockey table or a better manager. A financial reward system sets a precedent and creates expectations among your team members. It influences the behaviour of the individual and the culture within the organisation. Often for the good. But not always.
The above is only for your consideration. Once you’ve decided that an extra financial reward truly is an important motivator, don’t hesitate to continue reading this article.
You only give shares to the absolute top talents. Employees with entrepreneurship flowing through their veins. Because with a real share, your employee obtains unencumbered ownership of a part of the company, giving him the same rights as you. So you only give this incentive to team members you think are better than yourself and whom have proven their loyalty.
With shares, your employee becomes entitled to dividend. Naturally your employee also gets the possibility to sell his shares in due time (capital gains). Finally, he obtains voting rights and meeting rights at the shareholders’ meeting. He can therefore co-decide at the highest level of the company – the shareholders’ meeting. The extent to which he has influence, naturally depends on his percentage of shares.
Shares: how does it work in practice?
In some cases you can give your employee the shares for free (at nominal value). However, usually you will ask the employee to buy the shares. Doing so ensures your employee has ‘skin in the game’.
You need to lay down the agreements with your employee in a shareholders’ agreement. The shareholders’ agreement sets out conditions under which your employee receives the shares. The shareholders’ agreement contains many important provisions and it’s beyond the scope of this article to discuss them all. We suffice by giving two important provisions you must include in any case: (reverse) vesting and a leaver arrangement.
Example: Arthur is the founder of Unicorn B.V. Eric is an indispensable top talent. Arthur wants to have Eric as co-entrepreneur. Arthur gives Eric 36 shares that are subject to reverse vesting. If Eric becomes a leaver during the first 12 months, he has to hand in all his shares. After that, 1 share a month. This means that all shares are vested after 4 years. Upon dismissal with immediate effect or voluntary departure, Eric has to hand in the shares that are unvested. Now suppose that Eric decides to leave during month 11 because he wants to become a yoga teacher. In this case, he must return all of his shares. If this had happened during month 20, Eric would’ve been allowed to keep 7 shares.
Once you’ve laid down the arrangements in the shareholders’ agreement, you will need to visit the (civil-law) notary. The notary takes care of the issue of shares to your employee. Usually, the notary shall also amend the articles of association (to synchronize them with the new shareholders’ agreement).
Tax note 1: shares ‘as a gift’
‘Giving away’ your shares will (from a fiscal point of view) be possible only if those shares are worth € 0,- on the market. This is usually the case at an early stage tech-startup, when losses are being suffered and its value is in fact zero. But if your firm is making millions of profit on a yearly basis, giving away shares will lead to a tax claim for your company.
Because: if you give away shares with high market value, the tax authorities will consider the difference between the market value and exercise price as (net) income. Your company will be liable for a tax claim associated to the payroll taxes.
Tax note 2: providing a loan to an employee?
You can opt to provide your employee with a loan from the company, so he can buy the shares. The loan must be on commercial terms (i.e. interest, repayment, collateral). Your employee can (for example) repay the loan with the dividends from the shares. We don’t recommend you to finance the whole purchase amount – also letting your employee put in some money himself is an important test of character.
Tax note 3: privately held or holding B.V.?
Your employee has to establish what is most tax-efficient: holding shares in private or through a holding B.V.? Does your employee get less than 5% of the shares? Then it’s better to hold them in private. Does he get 5% or more? Then you should rather issue the shares to a holding B.V. This due to the ‘participation exemption’ (‘deelnemingsvrijstelling’) and the ‘substantial interest’ (‘aanmerkelijk belang’) rules.
2. Non-voting shares
With non-voting shares, your employee becomes entitled to the economic rights of the company (capital gains and dividend), but does not have voting rights. However, your employee does get to attend meetings and speak during those meetings (even though he can’t vote).
The latter can be annoying. Maybe you don’t want to share certain business information. Or maybe you have investors who don’t want to attend meetings with your employees. After all, the effectiveness of shareholder meetings is in inverse proportion to the number of participants. Non-voting shares are, therefore, suitable for one super employee who you don’t see as co-decision maker, but of whom you expect that he’ll become extra motivated if he can call himself shareholder. If you also intend to give other talents a share in the enterprise in the future, it’s better to choose for depository receipts (because those keep the decision-making clearer than non-voting shares).
Non-voting shares: how does it work in practice?
Non-voting shares are also “shares”. So just like ordinary shares, the following applies: (a) (usually) the employee has to purchase the shares, (b) you have to lay down arrangements in a shareholders’ agreement, and (c) you have to go to the (civil-law) notary for the issuance and amendment of articles of association.
Tax note: ‘type’ of shares
To determine whether there is of a “substantial interest” (whether the earnings are taxable regarding box 1 or 2) the Dutch tax authority looks at the percentage per class of shares held by that shareholder. What often goes wrong: voting shares are considered different from non-voting shares. If you give an employee 4% of the total shares, but he’s the only one who has non-voting shares (and the other 96% consists of ordinary shares), then effectively your employee has 100% of the shares from its kind. With other words: in that case he does not stay under the magic 5% limit for substantial interest, and that is a fiscal disadvantage.
3. Depository receipts
Depository receipts of shares are a typical Dutch phenomenon (and little known abroad). The shares themselves are owned by a Trust Office Foundation, a so-called “Stichting Administratiekantoor (StAK)”. Your employee gets a ‘depository receipt’ of that StAK; a right of action that is derived from the underlying share.
Depository receipt holders have no voting rights or rights of assembly. They do have the right to the economic advantage (sales profit and dividend). Bluntly: depository receipts are non-voting shares, but then without a right of assembly. Therefore, depository receipts are particularly suitable if you want to bind multiple employees to yourself.
Depository receipts: how does it work in practice?
Just like shares and non-voting shares, the employee (usually) has to purchase the depository receipts.
Again, you have to make proper arrangements with your employees. If you decide an employee is allowed to buy depository receipts, you have to conclude an agreement with three parties (the company, the StAK and the employee). The content of that agreement is largely the same as the shareholders’ agreement regarding (non-voting) shares: depository receipts are also subjected to vesting and a leaver arrangement.
Your employee is also bound to the so-called administration conditions (“administratievoorwaarden”). These contain the rights and obligations of the employee and StAK. For example, the administration conditions typically set out that a depository receipt entitles the employee to dividends and that – in case of an exit –depository receipt holders need to cooperate and co-sell their interests.
If you’ve come to an agreement with your employee, then such will need to be effectuated by the (civil-law) notary. The notary will execute (a) a deed issuance of shares, (b) a deed of constitution of the StAK, (c) a deed of certification of the shares.
4. Stock Appreciation Rights
Stock Appreciation Rights (SARs) have been relatively unknown in the Netherlands, but are becoming increasingly popular as the tech climate in the Netherlands expands. Instead of a share or a depository receipt, your employee becomes contractually entitled to the (increasing) value of a share in the company. It’s a “virtual” share.
SARs are suitable for employees that don’t want to (or can’t) buy in into the company, but who do expect an equity incentive. In comparison to shares or depository receipts, SARs are more flexible because they are purely contractual. However, you need to keep in mind that your employee will be less likely to feel ownership.
SARs: how does it work in practice?
The company and your employee enter into a contract. The contract states under which conditions the employee may exercise the SARs. This document is governed by freedom of contract – which means that you can ‘shape’ the SARs in many different ways. That also makes them attractive (although we immediately have to emphasize that it’s the art to keep them simple). In practice, SARs agreements often contain the following clauses:
- Vesting: as previously described.
- Leaver: as previously described.
- Exit: if an acquisition or stock market flotation is coming, your employee has the right (and obligation) to exercise his SARs.
- Dividend: in the agreement, you can also let your employee benefit from an interim profit distribution.
- Reservation regarding cash position: the company will pay no money to the employee if its financial situation doesn’t allow it.
- Earn out: your employee is obligated to remain with the company a little longer after an exit and to deliver good work (if the buyer requires that).
- Valuation: the amount of money that your employee receives sometimes depends on the valuation method you chose. If so, the agreement should provide more details on such valuation.
Tax note 1: disadvantage for the employee
With SARs, an employee is not obligated to ‘purchase’ the stock. In the beginning, this can be a good thing. But when you sell the company, and the employee gets his share of the money, that money will be taxed under income tax (box 1 (2016: 36,55-52%)). With shares, that would have been taxed in box 2 (2016: 25%) or box 3 (2016: effectively 1,2%).
Tax note 2 …advantage for the entrepreneur
For the company itself, SARs can be advantageous. The money paid out are regular costs, and can be deducted from company profits (thereby lowering corporate tax).
A ‘bonus’ is a simple (but effective) tool to reward an employee. It’s very flexible and comes in all shapes and sizes; from a 13th month to a three year retention bonus with clawback provisions.
Bonus: how does it work in practice?
Typically, an employee will have to reach targets to be entitled to a bonus. Such targets are laid down in the employement agreement (or an addendum to the employment agreement). It’s something of an art to set the right targets. Companies will often match targets to the employee’s function – relating to the employee’s key performance indicators (KPIs). Sales people, for example, typically have targets related to turnover.
To incentivize employees for the long term, ensure that the bonus only becomes available after the employee has stayed with the company for a longer period of time (e.g. 3 years). You can also choose to pay out a part of the bonus on an annual basis, and to ‘stack up’ the remainder at the end of a three year period. This will increase the chances of the employee staying on for the entire period of time.
Get to work!
For modern and innovative companies, maximum engagement of your employees is the way forward. True talent will not be retained with a salary increase only. They want a slice of the pie and they want to be part of a meaningful adventure.
This article has given you a broad scope of the options you, as an entrepreneur, have to get your team engaged. And to keep them that way. If you would like to go into more depth: we have assisted many growth companies with finding the right strategy for attracting and retaining key talent. We would love to continue the discussion with you, in person. Feel free to contact business attorney-at-law Philip de Roos or Sander Kooijman (business attorney-at-law specialised in employee participation schemes) directly.
De Roos Advocaten is a no-nonsense and transparent law firm based in Amsterdam. We are specialised in Corporate Law, Intellectual Property Law, Privacy Law and Commercial Litigation. We are the legal partner for growth, tech and social entreprises and their investors.