Written with help from Marc Habbema (SOWISO) and Menno Kolkert (Plot). Most startup founders plan to hire new employees in their first years. They are looking for the most talented people but do not have the cash to pay the highest salary. Therefore payment ‘in shares’ is often suggested. The best way to do this for a Dutch startup is to create a ‘STAK’: in this article we explain why and how.
Without special legal constructs, it is dangerous to issue shares to employees; you and employees can face large extra tax bills and when you loose touch with shareholders decision making can become impossible. Below we explain both risks in detail (the tax risk and the control risk) and explain how a STAK works.
A risky scenario
Suppose you have a startup with some founders and investors. You raise the money needed and start hiring developers in order to improve your product. Once you find a brilliant developer, you want to motivate them with more than money: you want to make him co-owner in the company and share the potential future success with him. So you offer him 5% of the shares in your company after one year. He accepts and starts working for you. It seems everything is going well.
- The existing shareholders’ agreement states that all other shareholders have to agree before you can issue shares. Some of the investors object and threaten to sue you as manager for mismanagement.
- The tax authorities value the 5% of your company that you give at € 100.000 based on the last funding round. Based on this, they send you an extra tax bill for € 52.000. (technically the employee has to pay the tax, however the employer has to make sure this happens).
Problems like these can bankrupt your company. So giving away shares, or promising shares below market value is not something you can do.
Problem 2: lost shareholders
One year later, you get the long-awaited call from Google: they want to buy your company. They offer you a nice round number, one billion dollar, provided the sale can be closed quickly. Speed is important. Unfortunately such a sale requires a signature from all shareholders. You have to contact all your employees and former employees. One of the shareholders is on a world trip and cannot be contacted. The notary refuses to authorize the deal, and Google buys a competitor instead.
The STAK is a special construct in which a not-for-profit foundation sells certificates of shares at realistic value to employees. The employees get all financial benefits of ownership as long as they are in the company. The foundation votes for the employees and buys the certificates back when the employee leaves. See this Dutch link for more info on starting one, or this now defunct example Grontmij STAK with English example statutes.
Assuming your company is loss-making directly after foundation, you can value shares at € 1 and the STAK can buy and sell the certificates at this price until at least the next funding round or first profitable year. The STAK never sells shares to employees: only certificates that entitle the employee to the financial benefits of the shares. You can start a STAK at any moment, but it is practical to do this at the first funding round. You tell the investor about the STAK plan and reserve a percentage (say 5% or 10%) of the shares for the STAK. In the STAK statutes you describe when and how much certificates each employee can buy and whether they have to sell them back to the STAK when they leave.
For completeness reasons we mention two other solutions to the problems mentioned. The problem of decision making can be simplified by installing a board. The board can approve operational decisions so you do not need approval of all shareholders for large expenses. However you cannot mandate a board for all actions, so the Google problem would remain.
An alternative for giving shares to employees is to issue options. However also options cannot be given away for free. Giving away options or other derivatives only invites more tax problems, since valuing options realistically is hard. (main image credit: Vincent van Dam)
About the author: Sieuwert van Otterloo (twitter: @entreprenl) gives management advice with a focus on IT-enabled business. He gives software related advice via the Software Improvement Group, startup and innovation advice via Inbys and manages his own venture fund Otterloo Ventures. He writes for Startupjuncture and Frankwatching.