*Disclaimer: This post is not a legal document. The main goal is to explain as simply as possible how to give equity to employees in Switzerland. It can be used as a great basis to have a conversation with your lawyer.
The TL;DR of this post is phantom options require less administrative overhead while options offer a tax optimization.*
It seems like a counterintuitive fact when a company is small, but believe it or not: equity is the most precious asset a startup has. If explained and used well, it can play a key role in motivating your employees to stay on board for the long run.
In Switzerland, there are two main ways to set up an employee participation plan: stock options and phantom stock options 👻 (aka virtual stock options). There's actually a third way, which is to give out stocks or restricted stock units (i.e. vested stock) but it's rare because it's a higher administrative overhead (a topic for another blog post). For now, let's focus on the two main approaches. Two factors are important to consider before choosing: tax and administrative overhead.
A stock option is a right for the employee to buy a stock at an agreed price (strike price) at a future date (exercise date).
No tax applies until the option gets exercised. Upon exercise, an income tax (typically 10–20%) applies on the difference between the stock's market value and the strike price (see Good to know below to find out how to determine these values). The graph below shows how much, at the end of the day, the employee receives for her options. The nice thing you can note here, is that if you own stock, you will benefit of the tax-free capital gain (specific to Switzerland) in the event that you sell your stock. Indeed, as stated above, the income tax only applies at the time of exercise and a sale of the company will result in a tax-free capital gain for everyone owning stock.
You first set up a pool, called bedingtes Kapital. You have to announce it to the notary who will put it in the statutes of your company. Once you have started giving out options, you have to go once a year to the notary (at the latest 3 months after the end of the financial year) to announce all the options which were exercised, i.e. converted to stock, during that year. Also, once the employee exercises his shares, he becomes a shareholder with all related rights immediately (such as participating to the general assembly).
A phantom stock option works the same way as a stock option except it can never convert to actual stock but instead are paid in cash.
No tax is applied to phantom stock options until they are 'exercised', which in this case means 'paid in money'. The time of exercise is often set to be the sale of the company or the IPO. Similarly to stock options, an income tax applies on the amount paid in cash to the employee. On the graph below you can see that the difference with stock options is that the amount that is subject to taxation is much higher since in this case the holder of stock can't take advantage of the tax-free capital gain.
The administrative overhead is clearly lower than with stock options: You can give out phantom stock options to your employees on the basis of a legal contract. You will never need to go to the notary for this.
If you're still unsure about what to choose, you're not alone and in the end it's a trade-off: Phantom options require less administrative overhead while options offer a tax optimization. To help you out, here's some data from Ledgy's database. We also asked a couple of famous law firms in Switzerland what plans their startups choose more frequently. If you want to share your plan and contribute to making this topic more transparent in Switzerland, we're more than happy to add you to this list!
The strike price is determined in a fairly arbitrary manner such as based on the most recent financing round, nominal value or fair market value. Try to make the strike price as low as you can, to maximize your employees' gain. The market value is determined by a fair market value that needs to be calculated according to the tax office guidelines (Formelwert or even do a Steuer-Ruling).
A "problem" that occurs with stock options is that you need to pay an income tax when you convert the options to stock. In this process you actually do not receive any money (but only stock) and at the same time you need to pay the tax. This can sometimes be problematic if the employees can't afford to pay the tax because they have a low salary. Phantom options, on the other hand, offer the advantage that the employee has to pay the tax only when he actually receives money (when the phantom option gets converted). However nowadays, startups tend to pay their employees a high enough salary so that paying the tax when exercising your options is not so problematic anymore.
Read more about it in our blog ESOP or PSOP?