When a startup is trying to lure in a big new hire, stock options are often a critical — and particularly attractive — component of the offer.
But for years, Germany has ranked as one of the worst countries with its burdensome tax rules around employee stock ownership programmes, or ESOPs. A new law passed by the Bundestag on Friday, however, should solve some of the most tricky issues by deferring taxation on stock options until they’re sold, rather than taxing them right away as a form of income, for a large swath of startups. VCs think it could prove to be a boon to the local ecosystem.
“It's the biggest reform in the history of the German startup scene,” says Christian Miele, general partner at VC firm Headline and chair of the German Startup Association. Compared to other countries, “We will not be number one, because there are just other tax regimes that are much more attractive than Germany. But we've made a huge jump now,” he tells Sifted.
The Bundestag voted on Friday to approve the draft law, dubbed the Future Financing Act, or Zukunftsfinanzierungsgesetz. It will now go to the Bundesrat, which is scheduled to meet next week. While the new act includes a variety of other provisions, including those aimed at improving access to capital markets for startups and small businesses, it’s the reforms to tax laws around ESOPs that are catching the eye of the startup community.
“I think it will help us to draw international talent, it will help us to keep talent within Germany,” Katharina Wilhelm, a Berlin-based partner at Index Ventures, tells Sifted.
Founders like Janina Möllmann, CEO of Gaia, which helps small businesses and other startups manage their legal documents and affairs, believe it would fix a major headache. She says her own startup will implement it quickly, and wagers that others will, too. “I believe that [for] the first few months of the new year, law firms will have quite a lot to do with startups trying to implement this,” she tells Sifted.
Germany’s tax laws around employee stock options have made it effectively impossible for startups to offer traditional programmes. The new bill includes changes to how employee stock options are taxed and increases the scope of qualifying businesses to include larger companies.
Historically, employee stock options were taxed as so-called “dry income” — meaning that employees had to pay taxes on their stock options when they were granted, rather than when they actually cashed them out. In other words, they were paying taxes on money they hadn’t received yet — which could be particularly problematic should they leave for another job or the company goes bust. To get around the problem, German startups have been issuing virtual shares, which aren’t technically real shares (they are essentially a type of bonus) and have their drawbacks.
“From a taxation point of view, they have the advantage — you do only have to pay taxes when you receive money. However, it is taxed as income and not just capital gains,” explains Jan Miczaika, partner at Berlin-based HV Capital. Income tax can be close to 50% in Germany, while capital gains tax is 25%. Miczaika estimates that about 80% to 90% of HV’s portfolio currently uses virtual share programmes (VSOPs).
Under the passed draft law, shares will only be taxed when they are sold, if the employer assumes the liability for the applicable tax wage, according to the Bundestag. “We are now solving dry income,” Miele says, “so it's actually huge.”
Still, some VCs say that the bill that passed doesn’t go far enough. “There have been some minor changes to the draft. It's one step in the right direction, but in comparison to other ecosystems, there's still a lack,” Earlybird’s Frédéric du Bois-Reymond tells Sifted.
The changes passed in the new Future Financing Act are expected to go into effect on January 1, 2024.
What does this mean for startups in Germany?
VCs emphasise that these changes would help make Germany a much more attractive place for employees to come to work for startups — which could spark a virtuous cycle of more companies being built, more talent opting to stay in the country, and, with the luck of a successful exit, more euros from those cashed-out employee shares being recycled back into the German startup ecosystem.
This “puts Berlin on a more even playing field with London and Paris,” Miczaika says.
That could be particularly crucial as battles over talent heat up in hot areas like AI, where Paris has emerged as an AI hub in Europe. “Especially when you think of new emerging sectors, like AI, you have extremely talented people who really value also the equity component and want to take risks,” Index’s Wilhelm says.
Still, startups will have a lot of work to do to figure out if and when they’d offer new programmes. “In the next few months, lawyers will need to figure out how to best structure also within the framework of this new law,” HV’s Miczaika says.