In an effort to rank Europe’s most start-up friendly countries, Index Ventures has compared the treatment of stock options across 20 European countries to policies in Israel, Canada, the US and Australia.
The results reveal five European countries with more favourable stock options rules than those in the US: Latvia, Estonia, Lithuania, France and the UK.
Stock options allow early employees of start-ups to acquire a slice of the company they work for. It is a tactic that has proven successful in helping early-stage Silicon Valley start-ups to compete for in-demand talent.
Across Europe, entrepreneurs, investors and start-up employees have been calling for reforms to stock options policies. One such pan-European campaign – Not Optional – is led by Index Ventures, a venture capital firm based in London, San Francisco and Geneva. In an open letter signed by 700 people involved in European start-ups, the campaigners wrote: “The next Google, Amazon or Netflix could well come from Europe, but for that to happen, reforming the rules of employee ownership is definitely not optional.”
‘While these policy changes will be welcome news to Latvian and Lithuanian start-ups, we now need the rest of Europe and the EU to follow suit’
– MARTIN MIGNOT
In recent years, both national governments and the European Commission have begun to address stock options rules in order to enhance competitiveness.
The Baltic nations of Latvia, Estonia and Lithuania in particular have been spotlighted by Index Ventures for their approach to stock options rules for start-ups. The entire region has been ranked top of the table, with all three countries achieving a maximum score of 30.
“It’s great to see policymakers in the Baltic countries with such a forward-thinking approach, recognising the value of the start-up economy and the role that entrepreneurs can play in creating jobs and economic growth,” said Index Ventures partner Martin Mignot, who leads the Not Optional campaign.
“While these policy changes will be welcome news to Latvian and Lithuanian start-ups, and start-ups expanding into those countries, we now need the rest of Europe and the EU to follow suit.”
Change is sure to come to more countries in Europe through the European Commission’s Startup Nation Standard, which addresses stock options among its actions to support the EU’s strategy for a globally competitive digital Europe.
Israel and Canada join the Baltic nations in the top five of the Index Ventures table, with France, the UK, Portugal, the US and Poland rounding out the top 10. Ireland comes in at 13th behind Italy and Sweden, while Belgium and Germany received the lowest ranking out of 24 nations assessed.
Countries in the runners-up category, such as Ireland, were downgraded because of the limited scope of schemes available. However, Index Ventures noted the encouraging move by the Irish Government to broaden its Key Employee Engagement Programme (KEEP) to allow for larger employee option grants.
‘Without the right policies in place, stock options can therefore seem worthless to employees’
– DOMINIC JACQUESSON
Germany, meanwhile, is expected to pass new legislation this year to enhance its competitiveness. In Belgium, however, where employees are hit with a tax at the moment they accept an option grant, Index Ventures director of talent Dominic Jacquesson said this has created an environment where few early hires stay with a start-up through to IPO.
“If leavers require a lot of cash to exercise their options, including taxation at exercise, they probably won’t bother, unless the company is clearly nearing a successful exit. Meanwhile, virtual schemes often offer nothing for leavers,” he said.
“Without the right policies in place, stock options can therefore seem worthless to employees. This can damage a company’s talent brand and is bad for the local start-up ecosystem as a whole.”
Latvia takes the top spot in the ranking thanks to policy changes introduced very recently, allowing slightly more flexibility than in Estonia.
The new rules in Latvia will apply to all limited liability companies for all employees as well as board members. The strike price (the amount an employee must pay to buy each share) can be set at the company’s discretion with no repercussions for a price lower than that of the previous round.
A distinctive feature of the Latvian system is that the minimum effective vesting period is reduced to a year, rather than three.
In Estonia, there is no specific scheme for start-ups, but the tax regime applicable to all private companies was found by Index Ventures to be exceptionally flexible and favourable.
Estonian companies can choose their own strike price, even a heavily discounted one, without creating any tax liability upon grant. Typically, companies in Estonia prohibit employees from exercising options for at least three years after grant, to avoid triggering tax liabilities. For employees, a flat rate income tax of 20pc then applies to the spread between strike price and sale price.
In February 2020, new tax-favourable legislation for the treatment of stock options came into effect in Lithuania. This applies to all private and public limited liability companies, for all employees and supervisory board members.
Companies in Lithuania can choose a strike price, even at a nominal value, without creating any tax liability upon grant. There is no requirement to do any formal valuation analysis.
Employee tax is payable at the point of sale, so long as options are held for at least three years prior to being exercised. After those three years have elapsed, there is also no employer tax liability.
Capital gains tax at a rate of 15pc or 20pc is applied at the point of sale to the difference between the sale and strike price.
Last year, France made changes to its stock option scheme which has seen it leapfrog the UK in the Index Ventures ranking. This expanded the scope of the popular BSPCE scheme so that non-French companies could also issue stock options to their employees in France.
The BSPCE scheme is less of a pure stock option and more like a restricted stock unit (RSU) – which is a promise from an employer to give an employee shares, or the cash equivalent, on a future date provided certain restrictions are met. However, it is tax advantaged. Employers don’t need to pay any tax or social security contributions, and employees don’t pay any tax until a sale of shares.
Most UK tech start-ups avail of the Enterprise Management Incentive (EMI) scheme, which is seen as a key factor in the country’s success as a European start-up hub. However, London alone has at least 50 tech start-ups that exceed the size criteria for the EMI scheme. This leaves larger start-ups and private companies stuck with less employee-friendly approaches, according to Index Ventures which recommends a broadening of the scheme.
“So long as the UK government maintains the most entrepreneur-friendly policies, including those around stock options, it will retain its position as the leading European start-up hub,” said Jan Hammer, a partner at Index Ventures.
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