ESOP in German startups

First published here by Thomas Grota, VC at T-Venture

Original post:

Thanks to Oliver Thylmann (@) and Manuel Koelman (@) for their support with this post!

Lately I was asked by journalists and founders regarding the standards and usual metrics of ESOP Employee Stock Option Plan) for Startup companies in Germany.

I was a bit surprised that there is so much uncertainty and hidden knowledge on this topic. So here is my view on the topic from the portfolio companies we work with as a venture capitalists. From my perception this is in line with most of the companies and VCs I know.

Why doing an ESOP for your company?

Easy answer: motivate your employees and to make sure the important people in your organization will participate in the exit. You might also be able to save cash and increase your runtime. The first reason is why you should do it, the second is a positive side effect. It will keep the people you want to stay in the company and let them feel a bit more as founders themselves.

What is the legal background and who can help?

Any lawyer with experience in venture capital can support you in the setup of an ESOP framework and the needed contracts, shareholder resolutions. However, most lawyers will start by talking about different possible solutions to build an ESOP, but founders should insist on the well known Phantom Stock model and just ignore the rest. All of my companies are using this model and I haven’t heard from any other company successfully using another model. Lawyers are paid to give you your options and many are not mentally geared yet towards the startup mindset of starting out with Good Enough.

What are the reasons for the Phantom Stocks as ESOP?

Main reason for this model is German tax laws and shareholders legal framework of a GmbH. In Germany, the receiving of shares can become an issue for taxation in case you are not a founder of a company, so not being a natural shareholder in a company from the beginning. If you are a founder you own the shares at nominal valuation and the value of those shares grew over time. In case someone gives you shares in a company with a value already established by e.g. a financing round, the German tax office treats this as an earning similar to a salary (“Lohnsteuer”). The receiver of those shares becomes taxable based on the valuation of those shares. In german tax laws you are taxed when you are receiving value and as a valuation of the shares has been established, you just got something of value if you receive real shares.

Example: Founders establish the company together and put in the nominal value of EUR 1 per share. For simplicity, we have one founder owning 25.000 shares, having put in 25.000 EURs at founding. With the seed round of 200.000 for a valuation of 1.000.000 EURs post funding, the new shareholder gets 6.150 shares for 20% of the company. The value of the shares of the founder have increased to 800.000 EURs but she already had those shares. She didn’t receive anything, similar to stock price increases in the stock market. But if you then want to create another 10% shares (3125 shares) and give it to an employee, then those shares have a value far above 3125 EURs and that person is getting those shares, getting that value. To be exact, it’s over 90.000 EURs in value, something the employee has received. Hence, that value needs to be taxed as income. Just imagine you are at a 50.000.000 valuation and want to give your newly hired star developer 1%… she would need to tax 500.000 EURs. Clearly a nogo.

The model of Phantom Stocks will create a right to get a virtual share in the company only materializing at the time of the exit. In this moment shareholders will commit a defined amount of the exit proceeds to the employees who took part in the ESOP Program. At this points the employee will receive hard currency in his bank account which is only taxable then. So she needs to be pay taxes when she is actually able to pay those taxes from the cash received.

How to create the virtual share pool to be reserved for employees?

This process is a simple legal document signed by all shareholders in a shareholder resolution or in the shareholder agreement. All shareholders will commit a certain part of the exit proceeds to be paid to those employees. Think of it simply as a few extra shares created at a certain data, fully dilutable like all the other shares, that come into existence at Exit. Presuming you had created a pool of 10.000 phantom shares when you had 40.000 shares, and then raised other rounds leading to 90.000 shares existing. At the time of the exit all costs of the transaction as well as liquidation preferences will be paid out to investors, and then instead of distributing the rest to 90.000 shares, you are distributing them as if 100.000 shares existed, just that the 10.000 phantom shares are paid out as bonus to the employees. As such, this is a dilution of shareholding in a virtual way for all shareholders. Usually I see that the commitment to implement an ESOP at seed stage among the seed investors and angels. Latest in a Series A round the ESOP will be put into the contracts and employees will receive a legal document approving their rights on the proceeds from this program.

How big is the ESOP and what amount is to be expected?

In almost all of my portfolio companies the ESOP is around 10% dilution of the shareholders. That means if the remaining pro-rata amount is EUR 11mn the ESOP will take EUR 1mn from the amount. This EUR 1mn will be divided according to the % each employee has in the ESOP. Typical amounts of ESOP for employees are from 0.25% up to 2.5% for an employee where as the upper limit is mainly for the real important and hired personnel like CSO, CTO and such. The standard for an employee is something around the 0.25% – 0.75%. That leads to an assumption that around 15-20 employees in a company taking part in this program while typical startup companies in B-Round stage have between 80 – 150 employees in total. That means around 20% of all employees will have a level or importance for the business to award them with an ESOP program, or you might create a second ESOP plan which is always possible. Currently we see in Germany exit valuations from EUR 20mn to EUR 50mn up to EUR 100mn – taking out exceptions like Trivago or unicorns like Delivery Hero and Rocket Internet companies. So when focusing on the sweet spot of German exits I guess the exit valuations are between EUR 25mn and EUR 45mn. To reach this kind of exits companies will take on EUR 5 – EUR 10mn of capital on the lower and EUR 20mn – EUR30mn on the upper end of this valuation range. Taking into account 1x liquidation preferences as a standard this means pro-rata proceeds will be in total between EUR 10 – EUR 15mn on the lower end and EUR 20 – EUR 30mn on the upper end. Exceptions where those exit valuations were EUR 100mn the pro-rata amount would be in the range of EUR 50mn – EUR 70mn from a gut feeling. That results into ESOP amounts of EUR 700k-1mn up to EUR 2mn – EUR 3mn. An employee would get therefore following those assumption depending on the success of the company and his percentage in ESOP somewhere from EUR 50k – EUR 500k. Looking into the EUR 100mn exits the amount will be above the EUR 1mn but hardly over EUR 2.5mn from this model. Those numbers seem to be correct from the experiences I have seen in exits in our portfolio of German companies. As always there are exceptions of the rules.

Disclaimer: Please be advised to still talk to your legal and tax professional.

Startup Weekend is coming back to Cologne

swcgn2_banner2This year again, the second Startup Weekend Cologne will take place on 24th – 26th of January 2014 at Startplatz, one of the nicest event places in the Cologne Tech Triangle Cologne.

Startup Weekend is a global grassroots movement of active and empowered entrepreneurs who are learning the basics of founding startups and launching successful ventures. It is the largest community of passionate entrepreneurs; As of April 2013, 1068 events have been held, involving over 100,000 entrepreneurs across more than 400 cities in over 100 countries and over 8190 startups have been created.

The non-profit organization is headquartered in Seattle, Washington but Startup Weekend organizers and facilitators can be found in over 200 cities around the world. From Mongolia to South Africa to London to Brazil, people around the globe are coming together for weekend long workshops to pitch ideas, form teams, and start companies.

All Startup Weekend events follow the same basic model: anyone is welcome to pitch their startup idea and receive feedback from their peers. Teams organically form around the top ideas (as determined by popular vote) and then it’s a 54 hour frenzy of business model creation, coding, designing, and market validation. The weekends culminate with presentations in front of local entrepreneurial leaders with another opportunity for critical feedback.

Whether entrepreneurs found companies, find a cofounder, meet someone new, or learn a skill far outside their usual 9-to-5, everyone is guaranteed to leave the event better prepared to navigate the chaotic but fun world of startups. If you want to put yourself in the shoes of an entrepreneur, register now for the best weekend of your life!

Student gets 50% with proper ID if they enter “student” code. And designers can bring another designer for free if they buy a designer ticket and mail us at cologne@startupwekend.org with both names.

“Life’s too short to build something nobody wants”

Just a quick heads up that Lean Startup pirate Ash Maurya is sailing directly from the US to Cologne for the first time! He is one of the top experts in Lean Startup and Customer Development, Speaker at the Lean Startup Conference, international best-selling author of Running Lean, and creator of Lean Canvas.

It’s a big success to have an expert like Asha Maurya come to Cologne. If you want to reach the next level of your Lean Startup knowledge, get your business model pimped and get in touch with Ash and the US startup world then we can highly recommend his workshop.

We have a special pirate discount of 20%. The code is: “leanpirates“. You can get your ticket here.

It’s a two day workshop, but it is also possible to buy a ticket only for one day. Here is additional information on goals and content of the workshop.

Interview with a VC – Kai Schmude // Venista Ventures

Today we will start our new interview seriews “Interview with a VC” and kick-off with interviewing Kai Schmude, COO at Venista Ventures. Enjoy!

Fund keyfacts Venista Ventures:venista_ventures_logo
–> Fund size: not public
–> Fund age/lifetime: company established in 2004, investment division set up in current form in 2010
–> Investment range in € and stage(s): 50,000 to 300,000 Euro, seed and early stage
–> Favorite co-investors: depends, but always smart money
–> Current investments: KissMyAds, Stylemarks, Startupbootcamp, Datapine, Klash, GTX Messaging.

Who are youkai_schmude_2?
I’m Kai Schmude. My position is Chief Operating Officer at Venista Ventures, the Cologne, Germany-based early-stage mobile investor. I joined the company in 2011 and oversee our operations as well as the development of Venista’s Mobile Business Incubator and early-stage investment activities. I’m a graduate from the University of Technology, Aachen, in both Engineering and Business. After founding and establishing an Internet startup and years in management consulting, I served as the Vice President of Cologne’s international Trade Fair, where I was responsible for the development and establishment of all IT and digital media shows including the world leading events dmexco and gamescom. Together with Venista Ventures’ founding partners Christian Teichert and Oliver Wimmeroth, I form the three-man management team. I focus on business development and acceleration and like to expand our network within the digital industry.

Why are you a VC?
We have the drive to build things and pursue them in a structured, result-driven way. Our company, Venista Ventures, is built on strong personal experience and business success of the founding team of entrepreneurs in the mobile industry. I joined this team and oversee the development of the company’s portfolio that has broadened into a proper VC with a focused area of activity. Venista Ventures became a VC because the company wants to identify and help develop promising startups in the mobile sector. We combine the practical approach of self-made businessmen with the structured and result-driven style of the executive world.

Tell us a bit about your fund & investment thesis?
We at Venista Ventures are dedicated to drive and enable mobile innovations. We support entrepreneurs with scalable mobile-centered business ideas. We believe: Developing and implementing an innovative and successful business will only work if you have the right combination of idea, team and partners. We are dedicated to help our portfolio companies to arrive there.

We provide early investments to entrepreneurs in the pre-seed and seed funding stages. We invest in and support entrepreneur sand teams with full determination to creating a great mobile business. We expect a clear and comprehensive plan, full commitment and the unconditional will to execute and to succeed. In addition to our investment, we are a partner for our portfolio companies, supporting them in with technical assistance, business planning, legal, financial, PR and marketing advice.

How do you work with your startups in day-to-day operations? What is your working mode?
Our approach is multi-optional so that each co-operation works in its own way. A key part of our strategy to work with startups is thorough business planning and analysis of KPIs. We provide financing and help with the strategic and managerial setup. We’re prepared to do more if our partners appreciate it. We offer consulting and operational support in a variety of fields, such as legal, marketing, communications etc. So the cooperation varies depending on the startup. Some reside a few meters away from my office and are tightly connected to our staff, others are in Berlin and very independent in their day-to-day activities.

What is the best advice you would give to startups that want to get funding?
Focus on the product and not on fantasy. It’s important to understand the market you’re in and to be willing to adapt initial plans as your experience grows. Before you seek funding, you should have climbed over the first few hurdles, analyzed and understood the market and established commitment from anyone involved in your startup.

What is the next big thing?
We see huge potential when it comes to the so-called Old Economy merging with the digital sphere of the Internet, be it mobile or stationary. Just think of the potential that Internet solutions can unfold in combination with two of the strongest traditional industries, Automotive and Health. Integrating new digital business models in these key industries is where I expect the most interesting developments to happen.

Checkout Startups, People, and Jobs in the Cologne Ecosystem

AngelListWe have already built a gazillion startup maps it feels and the biggest problem with many of them is that there is no benefit above and beyond the map itself. The map really isn’t all that important, a list would suffice. As long as it is something people continue adding to and that stays fresh.

We are attacking the problem for Cologne from different directions at the moment. For example, we are working together with the city of Cologne to build up a map for this year’s DMEXCO, which will be shown at the booth of the city. Watch out for a few startup talks there, too. Many of you might have noticed that the questionnaire that was sent around included a question for your AngeList profile. We did this for a reason.

For a good list to work, there needs to be a reason for you to add your startup to that list and if you think about it, there already is a system, where everybody of you should add their startup. AngelList! The site is already a force to be reconned with in the US, with a lot of funding happening over it and with the recent introduction of syndicates, they might arguably even replace smaller VCs and crowdfunding sites. When they introduced their jobs system, it was heralded because it fits startups looking for startup people from the get go, as there are no other people on that site. There is actually no reason for not adding yourself to AngelList. Both personally and as a Startup.

So without further ado, we introduce The Pirates Inn Startups, also to be found in the main navigation under “Ecosystem”.

This is a list with an added benefit, entirely built up via the AngelList API and soon with Crunchbase integration. All automatically, all fresh as the scene, but with a special view on the Cologne scene. Now go add yourself, your news, your jobs, and make the site fresh as the scene itself.