Startups Benefit From Employee Participation

Most startups cannot offer their employees a good salary. What they can do is offer shares. Unfortunately, Dutch startups that offer shares to employees as part of their salary face severe tax issues. These issues should be removed by the Dutch government. Every startup below a certain level of funding and turnover should be able to have its employees participate freely without adverse tax consequences. This would promote the startup climate in the Netherlands enormously.

Startups offer an important contribution to the economy. To date there are around 7,000 startups in the Netherlands, providing 16,000 jobs and generating a total turnover of 2 billion euros: young companies that have a scalable business model based on a technological invention (patent, software, etc.). Potentially, these are the new TomTom’s and ASML’s of the Netherlands, but only a small percentage will ultimately be successful. The financial resources of a startup are limited, especially in the very early stages. Securing financing from a bank is not an option and of course there are business angels and VCs, but only very few invest in very early stage startups. A startup wants to hire programmers or other technical staff to build and expand, but doesn’t have the money to do so. These employees are willing to accept a very low salary if they also get a stake in the company, which the founders are prepared to offer. From a fiscal point of view these shares are considered income. Consequently, the startup needs to withhold income tax, which in the end needs to be paid by the employee. Given that there was no money in the first place, this taxation poses a problem. Moreover, how should this salary in kind be valued? Coordination with the tax authority to determine a fair value is possible but takes time and money, which are both clearly absent.

In 2013, VVD MP Anne-Wil Lucas launched ‘Agenda StartupNL’, a proposal including 43 points of action to improve the Dutch startup ecosystem. One of these points concerned the tax hurdles for startups to offer shares as part of salary. In response to this, the Minister suggested that, instead of shares, startups could provide stock options, in which case taxation of the increase in value takes place upon the exercise of the option. The increase in value is taxed as income (box 1). Iif after a few years of hard work and struggling, a startup turns out to be successful and the employees of the first hour exercise their options, they need to pay 52% (income tax, highest rate) of the increase in value as a reward for their risk-taking! That is certainly no incentive and therefore rarely used in practice.

The Minister should facilitate that young innovative companies offer shares to employees as part of their salary. Without these facilities, startups will leave the country (the UK, for example, is much more flexible) or collaborations will simply not get established. The solution to the problem is very simple. As long as business angels and VCs have invested less than half a million euros in a startup and the startup has not made half a million of turnover yet, the startup is basically not much more than an idea. Since the success rate of these early stage startups is very low, their future uncertain, and the moment that positive cash flow will be generated often still far away, they could be valued at nil. The Minister should decide that granting shares to employees of startups that fulfill these criteria is possible against payment of the nominal value of these shares only. In that case there is no levy of income tax (box 1), since the shares are acquired assets (box 3). This is also in line with tax rulings that exist for life science startups. The amount of half a million is arbitrary and can be set slightly higher or lower, as long as a there is a clear threshold below which employees can participate freely. If the government wants to turn the Netherlands into a startup delta, then time has come for more concrete measures such as this one.

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