Democratizing Employee Equity in European Startups
The stories of startups reaching IPO and employees cashing in are legendary. Everybody knows someone who knows someone who helped build Company X, and is now sitting pretty.
It’s a key reason why employees join startups, and therefore a crucial part of many recruitment processes.
But generally speaking, these are American success stories. European startups are slowly embracing equity, but perhaps not with the same open-minded approach. So in a recent live CFO Connect webinar, we asked three experts with experience in this area to explain what so many founders and investors are missing.
Because while plenty of European startups have copied many of Silicon Valley’s best practices, generous employee stock options are not one of them.
Here are the five most compelling points raised and debated by our equity insiders.
You can watch the full webinar again any time here:
About our experts
Yoko Spirig is Co-Founder of Ledgy, an equity management platform for startups. Ledgy is used by many large scale-ups in Europe - including Wefox and Frontify - to manage hundreds of employee participation plans. It also helps startups share key information with their owners - including employees and investors.
Frank Freund is CFO and Co-Founder at Raisin, a Berlin-based fintech offering retail investors all across Europe access to the best-yielding savings products from banks, from instant savings accounts to 10-year fixed-term bonds. Raisin launched in 2012, and has gathered more than 250,000 customers, with almost €25 billion in assets.
Dominic Jacquesson has been VP Talent and Insight at Index Ventures for eight years. Index Ventures is a multi-stage, multi-sector VC fund founded in Geneva, but now operating evenly across Europe and the US. It has about 160 investments in total, with more than €6 billion under management. Current investments include Deliveroo, Discord, Alan, Raisin, and Spendesk.
European companies are behind the ball on employee equity
Employee stock options have long been a drawcard for businesses in the US to attract talent and grow. But for several reasons, they’re not offered widely in Europe. First, explains Frank, is a cultural issue.
“Employee equity requires shared insights and being transparent on valuation, and sharing numbers with the team. If leaders are not willing to be an open book to their employees, I wouldn't even start thinking about equity.” This radical transparency has been common in Silicon Valley for some time, but is only starting to take hold across Europe.
The second issue, Frank says, is complexity that comes from the various European member states. “We consider ourselves a pan-European company. We have employees in France, UK, Spain, and then also the US. But the German program doesn't work abroad, and vice versa. It's really difficult to administer and manage a larger workforce, and it's also costly.”
“And then there’s tax. Employees are taxed extremely disfavorably on equity, and significantly heavier than capital investors or founders. We need to change this, because we want those who join the team and who believe in what they're building to be successful at exit.”
So how does this situation compare with companies in the US? According to Dominic, American companies have standardized the way they use equity. It's a much more regimented model in the US, and best practice has been established. By the time they go to IPO, over 20% on average of the fully diluted equity in those tech companies will be owned by employees - excluding the founder.”
“You've got billions of dollars in the hands of employees and that can become liquid. In Europe, it's closer to 10%, and there's much higher standard deviation. There's a lot more variability. ”
And the biggest reason for this is maturity. “The more mature the ecosystem is, the more likely it is that somebody you're trying to hire will know somebody, will have a friend or have a contact who's done well out of stock options, or didn't get them in a big success and regretted it. They're going to be lobbying, and it's going to be important for them to receive them. They're going to know the value.”
And in Yoko’s view, this creates a cycle. “If employees of a successful startup get rich overnight in an exit, they tend to actually reinvest their new wealth into the ecosystem, by either founding a startup themselves or investing in startups. So in Europe, we need to make better policies to allow for these employee participation funds.”
Founders need to lead the way on equity
Naturally, most startup employees are excited by the idea of equity. But they’re not the decision makers. Instead, says Dominic, founders need to be proactive and set up these schemes. And this is becoming more and more common.
“There used to be a lot of founders who said ‘well, employees aren't really asking for it, so why should I give it away? What's the point of diluting all the rest of us?’ But I rarely hear that today.”
“It's a bit of a proof point for us as an investor. If we had a founder who was making that argument to us, it wouldn't be a particularly great signal in terms of our likelihood of investing in them, because it suggests they don't get it. That attitude isn’t likely to get you very far.”
So it needs to come from founders and executives at startups themselves. And once you’re onboard, it’s a matter of convincing the shareholders to come with you.
The key arguments for shared equity
Of course, some existing investors will always be slow to see the value of employee equity. So what are the best business arguments for putting this on the table?
“It really depends on the sophistication of investors,” begins Dominic. “And the best argument is talent retention. Because you can still get away in much of Europe with not offering a stock option program. But by the time you're the size of a Raisin or a Spendesk, you’re known as being a great talent pool and your people are going to be called up constantly with job offers, even from the likes of the big tech giants, as well as other startups.
“If you haven't created a reason for them to stay - because you can guarantee that Google or a bank could offer twice the salary - if you haven't created a moat to retain those people, you will lose them.”
And then there’s the economic argument. As Frank explains, “suppose you're in a scaling company, and you suggest that investors set aside an additional two and a half or 3%. They may push back, but of course we'll at least yield a 3% return. If you don’t believe that, then you shouldn't invest in us in the first place.”
But more than anything, says Frank, employee equity is a sign of future success. “I would just say, take the pain and do it. Because there are so many reasons and arguments to not do it, but nothing which can be an equally good incentive for companies that reached scale than granting ownership.”
“Rather than thinking about what your lawyer might be advising you or your accountant,” adds Dominic, “be strategic about this. Because that's how you're going to build a really truly world-class and winning organization.”
Access to equity needs to be equal
Some startups, says Dominic, are also tempted to offer equity only as a signing bonus, or to quietly give it to certain staff who ask for it. But this is asking for trouble. “That will leak out, and then it creates resentment and it quickly becomes negative for you. You're using your most valuable asset, using equity. It’s your most precious asset, and yet it's creating negative goodwill in your team, not positive.”
“Consistency and fairness are critical.”
Frank agrees on this point. “You need to have consistency in place because people talk, and you never want someone to leave just because they feel they’re not being treated in the way they should have been. It's something that people expect from you as a transparent leader, that you try to at least find ballparks or salary equivalents. Otherwise it'll sooner or later be realized that it's just not consistent across the organization.”
And there’s a practical element to this approach, too. Equity is complicated, and good communication is so important. “If you're giving stock options to some people but not everybody,” says Dominic, “it really limits your ability to educate around what they are. “Suddenly, you can't mention them at the all-hands, or you've got to have some sub-group or some sub-channel for people who've got stock options.”
“That feels undemocratic, anti-startup culture. But it also just makes things harder if you can't be open. Even if the most junior people in the organization have a small handful, it makes the job that much easier in education.”
And that communication should be thorough and engaging, adds Yoko. “ Startup leaders should definitely educate their employees. Not only on hard facts - mechanics of stock option plans - but most importantly be very transparent about the context. What are the values of these stocks you, the employee own? How are they going to develop? What is a realistic scenario, and what is a moonshot scenario?
“Really provide context to all the owners of your company.”
Don’t obsess over legal loopholes and clawbacks
When it’s time to actually build your employee equity plan, there’s a lot to consider and watch out for. Starting, says Dominic, with your legal advice. “Often the lawyers you're working with don't get the big picture, and will understandably try and do things in their client's interests. They’ll make sure that schemes are structured favorably to the company.”
Which can again create the wrong sentiment and may defeat the purpose of offering equity. “Tactically that might feel sensible and your lawyer might be urging you to do that, but the whole point is that if employees think your stock option scheme is weighted against them, it creates a real cynicism - ‘we'll never actually see anything out of this.’”
Many founders focus on stock options that only reward lifers, and punish those who leave. But while you want to recognize team members who stick around, you can still acknowledge those who worked diligently to build the company.
“If you're a successful startup,” says Dominic,” very few of your early employees are going to be there all the way through to a big exit. But those people were a really key part of your journey. They’re critical to your success, so treat them generously. And then if they're able to exercise, they become shareholders, they become advocates outside the organization. They become valuable alumni.”
“We're based in Switzerland and we allow stock option holders to exercise even after they’ve left the company,” says Yoko. “But within a time frame - around two years. It’s definitely important to leave this option open, and to allow employees to exercise and to leave in a good way.”
Letting staff keep or exercise stock options after leaving - even with a time limit - helps develop that sense of trust in the organization. And the same goes for letting staff exercise options prior to an exit, says Dominic. “If you can do some secondary - maybe at series B or C sort of stage - it's terrifically positive. Because it suddenly turns what is an intangible into some real money and some real financial upside. It makes the whole thing real. It gets people excited.”
To help you craft your company equity plan, and explore your different options, Index Ventures has created this OptionPlan tool.
Equity is more about fairness than economics
For founders and investors, offering employee stock options is naturally daunting. The idea of diluting company ownership - even a little - is most investors’ last resort.
But, as our experts have explained, there are two key rebuttals to this concern:
- The best talent has come to expect equity - especially in tech; and
- Without the best talent, the company will never reach its full growth potential.
So equity is in fact a real tool to drive growth. And if European startups, especially, want to compete with their US counterparts, they have to catch up quickly.
It’s no longer a matter of whether startups should offer equity, but rather when they should, and how much.
- Employee Stock Option and Phantom Share Plans (Pool Size, Vesting Schedule Examples) by Ledgy
- Rewarding Talent: A guide to stock options for European entrepreneurs by Index Ventures
- Check out Ekwity’s resource library for more information on equity than you could ever need