Welcome! If you’re reading this, you might just have accepted a new job at a startup – a job that offers you the chance to benefit from the company’s growth by awarding you virtual shares. Or, you might already own some virtual shares, and you’re wondering exactly what they mean for your compensation.
When you’re granted virtual shares in a company, you’re not just taking home a salary each month – your compensation is tied to the long-term growth of the business. But for many people, their virtual shares create lots of new questions about compensation. When do I get to cash out my virtual shares? Why do my virtual shares ‘vest’? What happens if and when I leave the company?
This one-stop guide to virtual shares and virtual share option plans (VSOPs) will help you answer these questions, and many more besides. Remember: this is just a guide. You should always check with your employer to find out exactly what your company’s VSOP and virtual share agreements mean for your compensation
What’s a VSOP?
Your share options will be part of your company’s virtual share option plan (VSOP). A VSOP is a type of employee participation plan that distributes virtual shares to team members. Some companies choose to grant equity to all employees, while others restrict virtual share awards to select groups of employees.
There are a couple of different ways for companies to set up VSOPs. One popular route is for the founder (or founders) to set aside some of their own shares to create a VSOP for employees.
When this happens, the founder retains their equity stake, but it is established that a pre-defined portion of their equity will be set aside as virtual shares for employees as and when the company exits.
Alternatively, the board can decide to allocate a pool of shares specifically for a VSOP, either by issuing new shares or by convincing existing shareholders to set aside some of theirs. Again, your virtual shares will only ‘convert’ into cash when the company exits.
Vesting and dilution
of companies in the US have at least some shares vesting over four years with a 12-month cliff.
of companies use this vesting model on average in the UK, Germany and France.
If you have virtual shares in your company, you’ll see that you don’t get awarded all your shares immediately after signing the contract. Instead, your virtual shares will vest over time.
Equity is designed to reward employees for their efforts over time, unlike, let’s say, bonuses which are paid out as a lump sum. Your company will set out in your contract how many of your virtual shares will vest each month, quarter, or year (vesting normally happens in monthly increments). But pay attention, because you’ll only start to see these regular vesting milestones once you’ve passed your cliff…
What’s a cliff?
A cliff is the period of time you have to work before being granted rights over any of your share options. The cliff is designed to prevent people qualifying for equity without making a significant contribution to the growth of the business.
It’s becoming normal for virtual shares to vest over a period of four years with a 12-month cliff at the start of the vesting schedule
How vesting works
Following this schedule, you’d have 25% of your shares vesting in one go after one year, with the rest of your options vesting in regular increments over the next three years:
Example 4 year vesting schedule with a 1 year cliff
Growing and raising capital from investors are generally positive signs for a business. But when companies raise money, there may be knock-on effects for the value of your virtual shares.
Dilution happens when new shareholders acquire stakes in a business, reducing the ownership percentages of the pre-existing shareholders. Although the number of share options each employee owns remains stable (outside of top-up grants), the percentage of the company those share options represent is reduced as the company issues additional shares to new investors. If your virtual shares come out of the founder(s)’ equity allocation, for instance, they will be subject to the same dilution as the rest of the founder’s ownership stake.
Cash settlements and tax
What’s a cash settlement?
Because virtual shares don’t involve actual company ownership, your payout when your company exits is known as a cash settlement.
When an exit event occurs, employees are paid the cash they’re due through payroll. Then, you’ll need to report your virtual share ownership to the tax authorities the next time you file your taxes. Your employer should give you a statement called a holding confirmation, which will have the information required to help you complete this step.
Let’s talk tax
When your business sells or lists publicly, tax will be due on any gains from your virtual shares. How much tax employees pay on their cash settlement varies by country.
In Switzerland, for example, the government gives a tax ruling on the nominal value of the virtual shares, which reduces the taxable amount. In the Netherlands, SARs are taxed as salary when the company exits, meaning that for people under pensionable age, at least 37% goes to taxes. In the UK, cashing out virtual shares comes under your income rather than capital gains, which leaves you with a larger tax bill (up to 45%).
Cash settlements and tax (cont.)
In Germany, employees with stock options are taxed twice: when the options convert to shares, and when the shares are sold. In contrast, the only time you’ll pay tax on your virtual shares is when there is an exit event.
Tax works differently in every country, and it’s important to consult with a legal advisor and/or tax professional when you’re thinking about your virtual shares.
What part of my cash settlement is taxed whenmy virtual shares pay out?
We designed this guide to help anyone who’s ever read a clause in their share option agreement and thought ‘What on earth does that mean?’ Whether you’ve been granted share options for the first time, or learning more about what your equity means for you, we hope you found our overview insightful.
As the tech ecosystem creates more category-defining companies, more and more people are being compensated with share options, which we love to see. But too often, the important ‘fine print’ of equity is too opaque or too technical for people to quickly understand.
The solution demands input from companies and team members. Companies need to be transparent with their people, giving them the information they need to understand their equity stakes and make sound financial decisions. And you should feel confident that your package is commensurate with market standards and that you’re being compensated fairly. Because when you’re up to speed with your equity, you can get to work in the knowledge that you’re contributing to something great.
Ledgy is the equity management platform built for scaling companies. We work with more than 2,500 businesses in over 40 countries around the world, including many of Europe’s fastest-growing and most innovative scale ups:
If you have any questions for us, please get in touch: firstname.lastname@example.org