How Employees Can Share in a Startup’s Success
Employees can share in the success of a company in various ways. Success-based pay can be an interesting way for young companies to attract and retain motivated employees.
Commission and participation in business results
Paying commissions is a special form of remuneration which is agreed for the conclusion or negotiation of a transaction. In contrast to time wage, workers are not compensated just for working, but only if they reach certain targets.
Generally, commissions are only due if the concluded transaction goes ahead and the customer meets its contractual obligations, or in other words, pays for the services received. In some cases, commissions become due on conclusion of the contract alone.
In contrast to commissions, profit or revenue sharing is not linked to individual customer transactions, but rather to the financial results of the whole company, or parts of the business. Commissions and revenue share payments are normally calculated on a quarterly or annual basis and are therefore linked to short term successes.
Appreciation rights and phantom shares
Longer term participation by employees in the increased value of a company can be reached through so-called phantom shares. These are fictional shareholdings in the company.
Beneficiaries are treated as shareholders from a property law perspective, but without the usual shareholder rights. This means that they are not entitled to exercise statutory information rights and do not have voting rights.
In the event of a sale, beneficiaries have a contractual right to share in the proceeds like owners. This right can be combined with a (purely contractual) right to dividend distribution, or another form of on-going profit participation.
Phantom shares can be “transferred” to employees either by individual agreement or in an employment contract. There are no specific formal requirements for this, and there is no need for a formal transfer of existing shares, nor for an increase in capital.
As there is no legal regulation of phantom shares, it is therefore even more essential that all rights and obligations are fully regulated in the agreement.
Otherwise, legal uncertainties may arise which can be difficult to resolve in the event of a dispute. If the issue of phantom shares impacts on the property rights of existing shareholders (dilution effect), it is sensible to obtain the explicit consent of those affected.
Employee shares and options
When employees are granted actual shares in a company, all the attached rights are transferred to the holders. These include, in particular, voting rights and information rights, as well as some protection from dilution, e.g., the right to maintain the existing shareholding quota.
Shares can be either allocated directly, or the right to acquire shares in the future can be granted (options). In this case, the price at which the holder can acquire shares within a certain period of time will be specified.
Where shares or options are being granted, it is common to agree “vesting clauses”. In this case, the full right to the shares only transfers to the holder after a defined period, and if certain conditions are met. For example, it could be agreed that early termination of the employment contract, or a material breach of contractual obligations, will lead to a (partial) loss of the granted rights.
Before board members or managing directors promise shares or options to their employees, they should ensure that such shares are either already available or can be created through an increase in capital, which requires a resolution of the general meeting. Finally, any tax implications of the preferred participation model should be ascertained before its implementation.