Employee incentives can be divided into two main groups: real equity and phantom equity. The benefits of the plan differ for each group. For VSOP and SAR, employees receive cash, while ESOP, warrants, and ESPP offer shares. We will explain each of these in detail.

Real equity

In countries with well-developed regulations or practices in the startup ecosystem, plans with real equity are commonly used. Such regulations may include tax reliefs or tax deferrals, where the tax point is shifted to the latter, and may define specific conditions that must be met to qualify for these tax reliefs under the law. As a result, establishing a universal incentive plan based on real equity across different jurisdictions becomes complex, as it would require adapting to each country's laws and meeting specific conditions for qualification.

ESOP

Under real equity plans the most popular is the ESOP – an employee share option plan under which options to buy shares are granted to employees over a specific period of time for a particular exercise price (also known as the strike price).
Currently, the friendliest legal treatment of ESOP is in the Baltic states - Latvia, Estonia, and Lithuania. In these countries, options can be given to employees for free and with a 0 exercise price because of the tax rules that do not tax the benefit from the discount if the required holding period for options is met. The minimum holding period of options is 12 months in Latvia and 36 months in Lithuania and Estonia until the options can be exercised and shares acquired by the employee to qualify under income tax laws. The exercise price can be the nominal value of shares.

WARRANTS

Another real equity plan used by startups in several countries is the warrant, which does not differ much from the ESOPs. Still, it adds another layer of complexity by the need to set up the value of the warrant itself. For example, in Sweden, warrant plans typically require an initial investment by the employee to achieve favourable tax treatment. Thus, the value of the warrant is needed. The employee might pay the company 5% to 20% of the last round's valuation to buy out the warrants.

OTHER

Some startups choose to use another real equity plan – ESPP, which stands for employee share purchase plan. At ESPP employees can purchase shares for an agreed price after all the applicable vesting requirements have been met. However, usually, there is no favourable tax treatment in Europe, and such benefits to employees will be taxed at the vesting date as income from employment.

Some countries provide specific regulations for employee incentive plans for startups or small businesses. For example, in France, there are warrants to subscribe for shares of a business creator known as BSPCE (Bons de souscription de parts de créateurs d’entreprise). BSPCE gives its beneficiary, under certain conditions, the right to subscribe to a share of the issuing company at a price predefined at the time it is granted (known as the strike price or exercise price).

Phantom equity

Plans with phantom equity are mainly used in countries with burdensome or no share option regulations. Lately, phantom equity plans are also more prevalent for distributed teams as it removes the need to adjust and qualify under various jurisdictions.

VSOP

Under phantom equity plans, the most popular is VSOP – the virtual share option plan. As its name already provides, the employee will not receive actual shares or options but is promised payment in cash if certain future events occur. Payment under VSOP is considered a bonus payment. However, the plan uses the same logic as actual ESOPs with vesting, cliff periods, and exit events. The benefit of VSOP is the simplicity of adopting and scaling it across different jurisdictions, as cash payments are taxed as income from employment.

SAR

Similar to VSOP, another phantom equity plan is SAR – share appreciation rights. As with VSOP, the employee shall not receive actual shares, but only the value of it in the form of a cash bonus, which is taxed as income from employment. The only difference from the VSOP is the terminology used. Everything else remains the same – vesting, cliff, and exit events.

Example use case

It gets more tricky when a group of companies wishes to introduce an employee incentive plan, as then questions arise such as: Which plan should we choose from? What rules should be applied? Will all employees be treated equally? How legally burdensome is it to apply the same plan to all employees, and is it even possible, and what consequences would there be?

To give you some insight, we have created an example use case, that gives a feeling of what could be considered in such a case.

1. Localisation

Localisation would require research on the long-term incentive plans used in each country and local requirements by law, probably in the local language. It might require some filing or notification requirements to local authorities.

The result might be as follows if the company wishes to benefit from favourable tax rules for ESOPs:

1. Latvia – ESOP – minimum holding period of 12 months, the exercise period of 6 months in case of leaving the company, a need to notify the State Revenue Service within two months of signing each grant agreement and submit ESOP details described in the form provided by law requirements;
2. Lithuania – ESOP – minimum holding period of 36 months, and at the moment of exercise employee must be employed by the company;
3. Estonia – ESOP – minimum holding period of 36 months, report the issuance of options to employees to the Estonian Tax and Customs Board, digitally signed or notarised;
4. Germany - VSOP - as VSOP has no specific regulation, a general VSOP template can be used to align with all other plans.

Where the admin burden to manage four different local requirements is high, the cost to implement plans per each country is also high. However, the result might be four different long-term incentive plans with tax efficiency in 3 out of 4 countries.

Spent time to implement: high

Cost to implement: high

Administration: high

Tax efficiency: ✅

2. Generalisation

Generalisation would be to take one of the countries' local legal requirements and use it for all countries.

However, if that is ESOP, it might raise the risk of taxation at earlier stages if it is not adjusted to the local tax rules. For example, if taken Latvian ESOP rules, then Lithuania, Estonia and Germany might be at risk of taxation at grant as a security not qualifying under the tax reliefs of ESOPs.

With VSOP, it would be easier, as the benefit of VSOP would be cash bonuses treated as income from employment and taxed accordingly in each country.

The end result might be one long-term incentive plan with no tax efficiency.

Spent time to implement: low

Cost to implement:  low

Administration:  low

Tax efficiency: ❌

‍

Conclusion

Whichever of the long-term incentive plans the company chooses to implement, it is good to remind oneself that even if there are favourable tax rules for long-term incentive plans, it does not necessarily limit the company in a given framework. Considering that, in most cases, these frameworks provide tax reliefs or tax deferrals where the tax point is shifted to the latter, it might not be a priority for the company at a given moment.

Additionally, it is worth noting that another layer of complexity will be added if the company has distributed teams across different jurisdictions.

Thus, it all breaks down to a tradeoff between speed, costs of implementation and administration, or being tax efficient. Therefore, which form of employee incentive plan is the most suitable will depend on individual circumstances and preferences.

‍