Hiring the first employee is one of the most crucial decisions a startup can make. This notion holds a significant amount of accuracy, though its clarity diminishes as time progresses. As years pass, the fundamental challenge for a technology venture shifts towards retaining essential personnel, while ensuring they remain highly motivated.
Working at startups is notoriously challenging. Technical roles require a substantial amount of motivation due to the demanding nature of the work. Moreover, frequent strategic shifts and operational turbulence are commonplace in such environments, and not every profile is set up to thrive in the startup setting.
Compensation plays a critical role here. For a growing number of professionals in this field, a market salary alone doesn't cut it anymore. They are aware that as demand for their skills increases, so does their value in the market. Consequently, engaging them in the company’s success becomes a key lever for ensuring a team that aligns with the company’s goals in the long term, especially during challenging times
Entrepreneurs are presented with various compensation options to complement the monthly salary in cash deprived startups. In the Spanish market, the choice often boils down to offering stock options versus phantom shares. Prior to the enactment of the much discussed Startup Law, stock options received one of the least favorable treatments in Western nations, making phantom shares a popular alternative in Spain.
In this post we’ll explain:
Understanding the distinction between stock options and phantom shares is crucial for both founders and employees.
A key distinction between both systems is related to taxes.
As explained above, stock options need to be exercised, which under most circumstances means having to use cash to do so, and also to pay taxes at the moment of the exercise.
The difference between the strike price and the market value of the shares at the time of exercise creates a profit (paper profit or dry income), that will be subject to income tax (the % that will be paid will depend on the tax bracket of the employee based on their income, as high as 47%; here’s a link to income tax brackets in Spain).
To make things a bit easier for the employee that has to make significant cash contributions at a time of high uncertainty, this dry income can be subject to two types of exemptions: i) an annual exception of €12k or a ii) 30% reduction if more than 2 years have passed between receiving the stock options and exercising them.
Once this happens, the employee will become a shareholder of the company: he or she will own actual shares.
If all goes well and the startup grows, those shares could appreciate in value substantially.
If an exit occurs (acquisition, IPO, etc), the difference between the market value of the shares at the time of exercise and the price per share at the time of the transaction will generate another profit (this time an actual profit, not dry income). This profit will be subject to capital gains tax, which in Spain is much lower than income tax (between 19% to 23%).
Also worth noting is the fact that, as a shareholder of the company, if the startup pays dividends, you’d have the right to receive those profits.
There is one more possibility in the case of stock options: in certain situations what might happen is that an employee of the company exercises its options and sells them at the same exact time (because there’s a liquidity window available, see below what this means). In this situation, the employee would pay income tax on the difference between the strike price and the price per share at which the sale takes place.
In this situation, there’s no advantage of paying lower taxes than the corresponding income tax, versus the previous example of paying capital gains. Although it’s true that you can get a reduction of the calculation of the income gains for the first €300k euros (at a 30% of that amount, that is you can deduct €90k to your total taxable income gain).
In essence, with stock options:
It’s worth noting that we don't intend to give any tax advice here, and you should always talk to a professional before any liquidity event to analyze your particular situation!
Phantom shares work differently.
Phantom shares are an economic right, meaning there’s no need for employees to exercise them. Employees with phantom shares will never become actual shareholders of the company.
If as an employee you receive phantom shares with a current value of X and those shares at the time of an exit are valued 3X, you’ll have to pay income tax on the value appreciation, the same way you would do if you would get an unexpected salary bonus.
As in the case of stock options, there’s a potential 30% reduction in the taxable income.
Phantom shares remove the financial risk for employees, as they do not have to invest their own money to purchase shares. The reward is directly linked to the company's performance, but employees do not benefit from dividends or have voting rights since they do not own actual shares.
In essence, with phantom shares:
This template is available here. For the sake of simplicity, we have not included potential tax exemptions and reductions in the table above.
As explained above, depending on the exercise period, stock options imply that the employee could have to make a substantial upfront cash investment.
Spain’s tax law has a €12k income tax exemption that makes things a little bit easier for the employee, but it doesn’t have a huge impact in our opinion.
The Startup Law introduced in Spain last year has several implications for stock options.
The Law introduces the concept of “empresa emergente". If you fit the criteria and receive the approval of ENISA (the organization that provides such certification), there are several benefits.
A startup “empresa emergente” is one that:
If a company meets the criteria and receives the certification from ENISA, it can offer the following stock option benefits to its employees.
The first point means that, in the case of the example above, the on-paper profit or dry income that would be subject to taxation would not be €200k, but €150k (€200k - €50k).
The last point is the most critical one. The payment of the income tax (€150k * 45% = €67.5k) can be deferred until an exit happens, until 10 years have passed since the stock options were executed or until the startup loses its “empresa emergente” criteria.
What this means is that if the company has not been sold in 10 years, the employee would then have to make the €67.5k income tax cash payment.
On the other hand, if the company losses its “empresa emergente” status, which would happen if the company grows its annual revenues above €10M, moves its headquarters to the US or grows older than 5 or 7 years… the employee would have to make the €67.5k income tax cash payment in the upcoming fiscal year.
We think the above is a critical point, since it sort of penalizes companies that are actually performing well. In our opinion this is one of the weakest aspects of the new Startup Law.
It’s also not clear what would be the best option for founders and startups once they grow past €10M in annual revenues. Go back to phantom shares?
Let’s just say that while the Startup Law introduced some improvements, in the case of stock options it did not do so to the extent that we would have liked, thus making the Spanish system less favorable than in other neighboring countries.
On this topic, we recommend this thread by David Miranda (Osborne Clarke) to understand the limitations of this new scheme. Also, if you want to dig deeper into the tax, governance and other implications for startups and founders, this article also by David is relevant and a recommended read.
As a fund with deep founding and operating experience, we’ve been in the shoes of our portfolio founders before. What follows is a series of suggestions that we’ve made to our founders in the past that could be also useful for the ecosystem at large.
To make things easier, in this section we will refer to either system (stock options or phantom shares) as simply “stock options”.
Our recommendation is to implement a stock option plan from the very beginning, and to make it effective once you make your first hires. Set aside around 10 to 15% of your cap table for stock options.
This becomes even more relevant when you hire mid management and also for key positions such as C-level roles or VPs.
Stock option pools (the number of option or phantom shares available) are often refreshed with every round of funding. New investors can ask for a pool of at least 5% to 10% to exist post-completion of the round.
Stock options are not as valued by future employees in Spain as in other more mature ecosystems. This is because there haven’t been as many exits as in other markets, thus employees tend to focus more on their salary than on equity-based compensation.
However, we think this is changing fast. As soon as employees have been part of an exit (or have friends who have been) and have received additional compensation due to having stock options, the chances that in their next job they’ll ask for stock upfront is very high. We believe this is a positive trend of a maturing and growing ecosystem.
This is a tricky one, and it really depends on the stage of your company, the seniority of the person you’re looking to hire and many other variables.
One rule of thumb that we suggest to our founders is to think about stock options as part of a total compensation package. What we mean by this is to use a multiplier of the employee’s base salary to assign stock options per employee. For example, 30% to 40% of the total salary for a specific role would be provided in stock options, at the last round valuation or 409A valuation, which defines the strike price.
Of course you can go beyond that range for exceptional talent or key contributors, usually a CXO in a series A startup would demand between 0,5 and 5% of equity depending on the experience, profile and fit with the company.
On this topic, we highly recommend Index Ventures' The Founder’s Guide to Stock Options and its Option Plan Calculator.
(409A valuation applies to US companies and it refers to the fair market value of a private’s company stock, and it determines the price at which employees can purchase shares through stock options. A 409A valuation is typically conducted by an independent third-party valuation expert or firm, using various valuation methods.)
Stock options are a retention mechanism for startups, so it makes sense that they’re attached to a retention strategy, also called vesting schedule.
The typical vesting schedule we suggest to our founders is 4 or 5 years. First year is often referred to as “cliff” and the remaining years as vesting period. What this means is that the employee will not have real access to its stock options until he stays for 1 year with the company. After that, the rest of the options vest on a monthly basis for the remaining 4 or 5 years.
If an employee leaves the company or is terminated before the cliff period ends, they do not vest any stock options and thus forfeit the right to buy any shares.
Per the example above, if an employee is granted 10k stock options with a one-year cliff and a four-year vesting period, they would not vest any options during the first year. At the end of the first year, assuming they are still employed, 2,500 options (1/4 of the total) would vest immediately. Subsequently, 208 options would vest each month over the next three years.
When an employee leaves a company, he or she is given a certain period of time to make the decision of whether he wants to execute the option to acquire the amount of vested he has the right to. This is called the exercise period.
The exercise period for vested stock options is a crucial consideration. This period defines how long the employee has to exercise (i.e., purchase) their vested options before they expire. Typically, when an employee leaves a company, they have a limited window to exercise their vested options. This period can range widely but is often set at 90 days after departure. It's crucial for employees to be aware of this timeframe, as failing to exercise vested options within this period usually results in forfeiting those options.
This is critical for employees, since a person might have to make a decision that will have significant cash implications (stock exercise plus taxes) with a high degree of uncertainty about the company’s future.
This is why some companies in Silicon Valley and other regions have implemented unlimited or very large exercise periods.
On this topic, we often recommend our startups to make the exercise period proportional to the time an employee has been at the company, in order to reward those that stick around longer. For example, if you’ve been at a company for 8 years as an employee, provide that person with months (or years) to exercise their options instead of the usual 90 days.
It’s also worth noting that exercise periods are often dependent on why the employee is leaving the company (bad leaver and good leaver clauses). An employee might be let go due to a relevant circumstance and lose all or part of their options/shares.
Also, although phantom shares don’t need to be exercised, they should still be subject to a vesting schedule.
Employees can have different liquidity events. Obviously at the time of an exit, but also in the following circumstances.
When an exit happens, outstanding shares and options are often “accelerated”. This means that they are assumed to have been vested and the stock options exercised, in order to reward the employees that might have unvested shares. However, this ultimately depends on whether single trigger or double trigger clauses have been put in place.
Single trigger acceleration refers to a provision where stock options vest automatically upon a single event, typically a liquidity event such as the sale of the company. This makes stock options exercisable by the option holder and thus allows the employee to sell its stock at the time of an exit.
While beneficial for employees and certain investors, single trigger acceleration can be less attractive to potential acquirers or partners, as it might lead to significant changes in employee ownership or motivate key employees to leave post-acquisition.
Double trigger acceleration requires two distinct events to occur for stock options to accelerate and vest ahead of schedule. These events typically include a change of control (like an acquisition) and an adverse employment action (such as termination or a significant demotion) within a set period after the change of control.
This scheme provides employees with protection against losing unvested options if they are terminated without cause following a change of control.
Double trigger clauses are more widely accepted because they balance the interests of employees and acquirers. They incentivize key employees to stay through a transition period while providing a safety net if their employment status changes unfavorably.
To make things easier for founders, two of our portfolio companies were kind enough to share two templates for phantom share plans
Once we have a template for stock plans, we'll also add it to the post.
Hope they’re useful!
Special thanks to Jorge Lluch (Abacum), Carlos Sánchez (indemniza.me), Pablo Fernandez Ripoll (Moore) and Pablo Pazos (Barkibu).
Hiring the first employee is one of the most crucial decisions a startup can make. This notion holds a significant amount of accuracy, though its clarity diminishes as time progresses. As years pass, the fundamental challenge for a technology venture shifts towards retaining essential personnel, while ensuring they remain highly motivated.
Working at startups is notoriously challenging. Technical roles require a substantial amount of motivation due to the demanding nature of the work. Moreover, frequent strategic shifts and operational turbulence are commonplace in such environments, and not every profile is set up to thrive in the startup setting.
Compensation plays a critical role here. For a growing number of professionals in this field, a market salary alone doesn't cut it anymore. They are aware that as demand for their skills increases, so does their value in the market. Consequently, engaging them in the company’s success becomes a key lever for ensuring a team that aligns with the company’s goals in the long term, especially during challenging times
Entrepreneurs are presented with various compensation options to complement the monthly salary in cash deprived startups. In the Spanish market, the choice often boils down to offering stock options versus phantom shares. Prior to the enactment of the much discussed Startup Law, stock options received one of the least favorable treatments in Western nations, making phantom shares a popular alternative in Spain.
In this post we’ll explain:
Understanding the distinction between stock options and phantom shares is crucial for both founders and employees.
A key distinction between both systems is related to taxes.
As explained above, stock options need to be exercised, which under most circumstances means having to use cash to do so, and also to pay taxes at the moment of the exercise.
The difference between the strike price and the market value of the shares at the time of exercise creates a profit (paper profit or dry income), that will be subject to income tax (the % that will be paid will depend on the tax bracket of the employee based on their income, as high as 47%; here’s a link to income tax brackets in Spain).
To make things a bit easier for the employee that has to make significant cash contributions at a time of high uncertainty, this dry income can be subject to two types of exemptions: i) an annual exception of €12k or a ii) 30% reduction if more than 2 years have passed between receiving the stock options and exercising them.
Once this happens, the employee will become a shareholder of the company: he or she will own actual shares.
If all goes well and the startup grows, those shares could appreciate in value substantially.
If an exit occurs (acquisition, IPO, etc), the difference between the market value of the shares at the time of exercise and the price per share at the time of the transaction will generate another profit (this time an actual profit, not dry income). This profit will be subject to capital gains tax, which in Spain is much lower than income tax (between 19% to 23%).
Also worth noting is the fact that, as a shareholder of the company, if the startup pays dividends, you’d have the right to receive those profits.
There is one more possibility in the case of stock options: in certain situations what might happen is that an employee of the company exercises its options and sells them at the same exact time (because there’s a liquidity window available, see below what this means). In this situation, the employee would pay income tax on the difference between the strike price and the price per share at which the sale takes place.
In this situation, there’s no advantage of paying lower taxes than the corresponding income tax, versus the previous example of paying capital gains. Although it’s true that you can get a reduction of the calculation of the income gains for the first €300k euros (at a 30% of that amount, that is you can deduct €90k to your total taxable income gain).
In essence, with stock options:
It’s worth noting that we don't intend to give any tax advice here, and you should always talk to a professional before any liquidity event to analyze your particular situation!
Phantom shares work differently.
Phantom shares are an economic right, meaning there’s no need for employees to exercise them. Employees with phantom shares will never become actual shareholders of the company.
If as an employee you receive phantom shares with a current value of X and those shares at the time of an exit are valued 3X, you’ll have to pay income tax on the value appreciation, the same way you would do if you would get an unexpected salary bonus.
As in the case of stock options, there’s a potential 30% reduction in the taxable income.
Phantom shares remove the financial risk for employees, as they do not have to invest their own money to purchase shares. The reward is directly linked to the company's performance, but employees do not benefit from dividends or have voting rights since they do not own actual shares.
In essence, with phantom shares:
This template is available here. For the sake of simplicity, we have not included potential tax exemptions and reductions in the table above.
As explained above, depending on the exercise period, stock options imply that the employee could have to make a substantial upfront cash investment.
Spain’s tax law has a €12k income tax exemption that makes things a little bit easier for the employee, but it doesn’t have a huge impact in our opinion.
The Startup Law introduced in Spain last year has several implications for stock options.
The Law introduces the concept of “empresa emergente". If you fit the criteria and receive the approval of ENISA (the organization that provides such certification), there are several benefits.
A startup “empresa emergente” is one that:
If a company meets the criteria and receives the certification from ENISA, it can offer the following stock option benefits to its employees.
The first point means that, in the case of the example above, the on-paper profit or dry income that would be subject to taxation would not be €200k, but €150k (€200k - €50k).
The last point is the most critical one. The payment of the income tax (€150k * 45% = €67.5k) can be deferred until an exit happens, until 10 years have passed since the stock options were executed or until the startup loses its “empresa emergente” criteria.
What this means is that if the company has not been sold in 10 years, the employee would then have to make the €67.5k income tax cash payment.
On the other hand, if the company losses its “empresa emergente” status, which would happen if the company grows its annual revenues above €10M, moves its headquarters to the US or grows older than 5 or 7 years… the employee would have to make the €67.5k income tax cash payment in the upcoming fiscal year.
We think the above is a critical point, since it sort of penalizes companies that are actually performing well. In our opinion this is one of the weakest aspects of the new Startup Law.
It’s also not clear what would be the best option for founders and startups once they grow past €10M in annual revenues. Go back to phantom shares?
Let’s just say that while the Startup Law introduced some improvements, in the case of stock options it did not do so to the extent that we would have liked, thus making the Spanish system less favorable than in other neighboring countries.
On this topic, we recommend this thread by David Miranda (Osborne Clarke) to understand the limitations of this new scheme. Also, if you want to dig deeper into the tax, governance and other implications for startups and founders, this article also by David is relevant and a recommended read.
As a fund with deep founding and operating experience, we’ve been in the shoes of our portfolio founders before. What follows is a series of suggestions that we’ve made to our founders in the past that could be also useful for the ecosystem at large.
To make things easier, in this section we will refer to either system (stock options or phantom shares) as simply “stock options”.
Our recommendation is to implement a stock option plan from the very beginning, and to make it effective once you make your first hires. Set aside around 10 to 15% of your cap table for stock options.
This becomes even more relevant when you hire mid management and also for key positions such as C-level roles or VPs.
Stock option pools (the number of option or phantom shares available) are often refreshed with every round of funding. New investors can ask for a pool of at least 5% to 10% to exist post-completion of the round.
Stock options are not as valued by future employees in Spain as in other more mature ecosystems. This is because there haven’t been as many exits as in other markets, thus employees tend to focus more on their salary than on equity-based compensation.
However, we think this is changing fast. As soon as employees have been part of an exit (or have friends who have been) and have received additional compensation due to having stock options, the chances that in their next job they’ll ask for stock upfront is very high. We believe this is a positive trend of a maturing and growing ecosystem.
This is a tricky one, and it really depends on the stage of your company, the seniority of the person you’re looking to hire and many other variables.
One rule of thumb that we suggest to our founders is to think about stock options as part of a total compensation package. What we mean by this is to use a multiplier of the employee’s base salary to assign stock options per employee. For example, 30% to 40% of the total salary for a specific role would be provided in stock options, at the last round valuation or 409A valuation, which defines the strike price.
Of course you can go beyond that range for exceptional talent or key contributors, usually a CXO in a series A startup would demand between 0,5 and 5% of equity depending on the experience, profile and fit with the company.
On this topic, we highly recommend Index Ventures' The Founder’s Guide to Stock Options and its Option Plan Calculator.
(409A valuation applies to US companies and it refers to the fair market value of a private’s company stock, and it determines the price at which employees can purchase shares through stock options. A 409A valuation is typically conducted by an independent third-party valuation expert or firm, using various valuation methods.)
Stock options are a retention mechanism for startups, so it makes sense that they’re attached to a retention strategy, also called vesting schedule.
The typical vesting schedule we suggest to our founders is 4 or 5 years. First year is often referred to as “cliff” and the remaining years as vesting period. What this means is that the employee will not have real access to its stock options until he stays for 1 year with the company. After that, the rest of the options vest on a monthly basis for the remaining 4 or 5 years.
If an employee leaves the company or is terminated before the cliff period ends, they do not vest any stock options and thus forfeit the right to buy any shares.
Per the example above, if an employee is granted 10k stock options with a one-year cliff and a four-year vesting period, they would not vest any options during the first year. At the end of the first year, assuming they are still employed, 2,500 options (1/4 of the total) would vest immediately. Subsequently, 208 options would vest each month over the next three years.
When an employee leaves a company, he or she is given a certain period of time to make the decision of whether he wants to execute the option to acquire the amount of vested he has the right to. This is called the exercise period.
The exercise period for vested stock options is a crucial consideration. This period defines how long the employee has to exercise (i.e., purchase) their vested options before they expire. Typically, when an employee leaves a company, they have a limited window to exercise their vested options. This period can range widely but is often set at 90 days after departure. It's crucial for employees to be aware of this timeframe, as failing to exercise vested options within this period usually results in forfeiting those options.
This is critical for employees, since a person might have to make a decision that will have significant cash implications (stock exercise plus taxes) with a high degree of uncertainty about the company’s future.
This is why some companies in Silicon Valley and other regions have implemented unlimited or very large exercise periods.
On this topic, we often recommend our startups to make the exercise period proportional to the time an employee has been at the company, in order to reward those that stick around longer. For example, if you’ve been at a company for 8 years as an employee, provide that person with months (or years) to exercise their options instead of the usual 90 days.
It’s also worth noting that exercise periods are often dependent on why the employee is leaving the company (bad leaver and good leaver clauses). An employee might be let go due to a relevant circumstance and lose all or part of their options/shares.
Also, although phantom shares don’t need to be exercised, they should still be subject to a vesting schedule.
Employees can have different liquidity events. Obviously at the time of an exit, but also in the following circumstances.
When an exit happens, outstanding shares and options are often “accelerated”. This means that they are assumed to have been vested and the stock options exercised, in order to reward the employees that might have unvested shares. However, this ultimately depends on whether single trigger or double trigger clauses have been put in place.
Single trigger acceleration refers to a provision where stock options vest automatically upon a single event, typically a liquidity event such as the sale of the company. This makes stock options exercisable by the option holder and thus allows the employee to sell its stock at the time of an exit.
While beneficial for employees and certain investors, single trigger acceleration can be less attractive to potential acquirers or partners, as it might lead to significant changes in employee ownership or motivate key employees to leave post-acquisition.
Double trigger acceleration requires two distinct events to occur for stock options to accelerate and vest ahead of schedule. These events typically include a change of control (like an acquisition) and an adverse employment action (such as termination or a significant demotion) within a set period after the change of control.
This scheme provides employees with protection against losing unvested options if they are terminated without cause following a change of control.
Double trigger clauses are more widely accepted because they balance the interests of employees and acquirers. They incentivize key employees to stay through a transition period while providing a safety net if their employment status changes unfavorably.
To make things easier for founders, two of our portfolio companies were kind enough to share two templates for phantom share plans
Once we have a template for stock plans, we'll also add it to the post.
Hope they’re useful!
Special thanks to Jorge Lluch (Abacum), Carlos Sánchez (indemniza.me), Pablo Fernandez Ripoll (Moore) and Pablo Pazos (Barkibu).
