Employee participation in early-stage start-ups: work for equity from a legal perspective

In the early phase of a start-up, there is often a lack of liquidity to pay salaries in line with the market. This is why many founders rely on employee participation based on the principle of work for equity – i.e. work in exchange for company shares. Employees are given a stake in the future success of the company, either through real shares or virtual promises, instead of (or in addition to) immediate salary payments. This model promises to attract and retain talented specialists in the long term despite tight budgets. However, work for equity raises complex legal issues as it lies at the interface of employment law and company law. At the same time, the question of fairness arises: under what conditions is employee participation a fair offer and when does it become a one-sided transfer of risk to early employees? In the following, opportunities, risks and specific forms of structuring such as vesting (or reverse vesting) and anti-dilution clauses are examined in detail. The distinction between employment law obligations, company law requirements and entrepreneurial concepts (e.g. slicing the pie) will be worked out. Different forms of participation (virtual vs. real shares, monetary participation) and their contractual implementation – including typical clauses and current case law – are also presented. The aim is to provide a legally sound overview that helps start-ups in Germany in particular to structure work for equity in a legally secure and fair manner. Tax and social security aspects are only mentioned in passing.

Forms of employee participation in startups

Employee participation can take place in various ways. There are basically three main forms:

• Virtual shares (virtual stock options, phantom stocks, etc.): Here, employees receive virtual company shares that do not convey any real shareholder status. In legal terms, this is a purely contractual commitment, usually in the form of a virtual stock option plan (VSOP). Employees have no direct shareholder rights or obligations (no voting rights, no direct profit participation rights). Instead, in the event of success (typically on sale of the start-up or exit), a bonus payment in the amount of the value of a certain share is promised. In economic terms, they participate in the value of the company without formally holding shares. The main advantage of these virtual models is their uncomplicated implementation: there is no need for notarization or entry in the commercial register, as no real shares are transferred. The founders retain full freedom of decision and different calculation methods (e.g. percentage share of exit proceeds) can be flexibly agreed. In addition, the tax burden for the employee generally only arises at the time of payment (exit) – ideally only when the employee generates liquidity from the share. The disadvantage is that virtual shares do not give the employee any say and, as mere contractual claims, can be less secure in the event of the company’s insolvency. Nevertheless, VSOP programs have now become the standard in the German start-up sector, as they avoid many practical hurdles.
• Genuine company shares (direct participation): Alternatively, employees can be made genuine co-partners, for example by transferring shares in a GmbH or issuing shares/options in an AG. This offers the highest degree of identification – the employees become full legal shareholders with all rights (e.g. voting rights, information rights). This gives them a strong sense of ownership in their “own” company and gives them a direct stake in its success. However, the granting of genuine shares is associated with considerable disadvantages. On the one hand, it leads to a potentially extensive shareholder structure, which makes resolutions and decisions more difficult. Every new shareholder must be entered in the list of shareholders, and in the case of GmbHs, every transfer requires notarization (Section 15 GmbHG) and registration in the commercial register. On the other hand, the inclusion of many small shareholders means additional administrative and financial work. For example, participation agreements have to be negotiated with each employee, and investors may shy away from a confusing list of owners. Finally, there are tax disadvantages– at least according to the current legal situation: The non-cash benefit from genuine shares must generally be taxed by the employee at the time they are granted, i.e. at a time when they have not yet earned any income from the shares. In the worst case scenario, the employee will not have the money to pay the tax due. (This so-called dry income problem is addressed below in the section on new legal developments). For these reasons, start-ups have long avoided real employee stock ownership plans (ESOPs), preferring to use virtual structures. Although genuine participation promotes maximum loyalty, the disadvantages for all parties involved often outweigh the advantages in dynamic start-ups – the risks (complicated resolutions, tax burdens, etc.) should not be underestimated, especially with changing employees and upcoming financing rounds.
• Monetary participation (profit sharing, silent partnership, etc.): In addition to equity models, it is also possible for employees to participate in the company’s success in monetary terms without holding shares under company law. For example, profit-sharing or performance bonuses can be agreed that are linked to specific company targets. Employee loans with performance-related interest or profit participation rights (profit-participating subordinated loans) can also be considered. Another variant is the silent partnership in accordance with §§ 230 ff. HGB: The employee joins the commercial enterprise as a silent partner, makes an asset contribution (e.g. by contributing part of their salary) and receives a contractual profit share in return. The silent partnership establishes a genuine corporate relationship, but the employee does not appear externally and generally has no say; he only participates in the profit (and optionally in the loss). Such monetary forms of participation are often debt capital under accounting law (i.e. no voting rights), but can be structured flexibly. Their advantage lies in the fact that they can be granted in addition to salary – they are more like bonus models that promote entrepreneurial thinking without fundamentally changing the employment relationship. However, there is no ownership status here: employees remain traditional employees with a bonus entitlement, which means less risk for them, but also less potential upside in the event of a major exit.

In practice, start-ups often combine these models. For example, a key employee may receive a lower salary plus VSOP, while a co-founder holds real shares. Which form of participation is appropriate depends on the start-up’s goal and the employee’s position. VSOP programs are often geared towards an exit, while real shares allow for ongoing profit sharing. In view of the aforementioned advantages and disadvantages, most German start-ups are currently opting for virtual shares (VSOPs) rather than real employee shares, partly because this was the only practicable solution in terms of tax and administration until recently. Nevertheless, genuine participation programs – for example via share options – are becoming increasingly attractive, especially as new laws are making this easier (see below on the Future Financing Act).

Opportunities and risks of Work for Equity

In theory, employee participation offers advantages for all sides. At the same time, however, it harbors risks and disadvantages that need to be carefully weighed up in practice.

Advantages and opportunities

• For the start-up (founder side): Through work for equity, a start-up can attract urgently needed specialists that it would otherwise not be able to afford. Studies prove the high motivation factor of equity participation – employees are more committed when they participate in the company’s success. At the same time, equity participation promotes the long-term retention of important talent in the company. Especially in competitive labor markets, an attractive equity package can be the decisive factor in attracting top talent. Another advantage lies in the financing: employees who waive part of their salary or even contribute their own capital strengthen the company’s capital base. This can reduce or delay the need to raise outside capital. All in all, Work for Equity makes it possible to remain competitive despite tight liquidity and to move the company forward by joining forces.
• For employees: A shareholding gives employees the opportunity to participate disproportionately in future success. If the company value increases significantly, the value of their shares or options can amount to a multiple of a normal bonus in the event of success. Early employees in particular can benefit considerably financially in the event of an exit, similar to founders. In addition, a shareholding conveys a sense of ownership: employees also see the company as “their” company and take on more responsibility. This sense of co-entrepreneurship can make work more fulfilling than a purely salaried job. In addition, depending on the model, entrepreneurial skills are promoted as employees gain more insight into financial contexts. Another practical advantage of virtual shareholdings is the tax deferral: unlike with real shares, the benefit is usually only taxed when money actually flows in (exit proceeds). This means that the employee does not have to pay tax when they receive the shareholding, as is often the case, but can instead pay it conveniently from the profit. All in all, a fairly structured shareholding can be extremely rewarding for employees – they become co-entrepreneurs and not just a cost factor.
• For investors/business angels: Investors also see advantages in employee shareholdings. A team that has a stake in the company is seen as more motivated and committed, which benefits the start-up’s chances of success – an important aspect for investors who back the team. In addition, an existing investment program shows that the founders have planned professionally and are willing to share equity to enable growth. Many investors already include an employee participation pool in their term sheets so that dilution through subsequent employee shares is taken into account from the outset. Another advantage is that if key employees are retained (through vesting etc.), this indirectly protects the investment – there is less risk of an essential team member leaving the company without a replacement. Last but not least, an ESOP/VSOP program meets international standards, which sends a good signal to foreign investors in particular: The company works according to best practices and the interests of the team and shareholders tend to be aligned.

Risks and disadvantages

• For employees: For employees, work for equity is always a bet on the future. The main incentive is often the hope of a lucrative exit, but this does not always materialize. Statistically, many start-ups fail or do not achieve the hoped-for valuations – in such cases, employees with an equity stake go away empty-handed, while they have foregone their salary. This uncertainty of success is not offset by a safety net; the normal fixed salary that would have been received in an established company is irretrievably lost. In addition, many employees are not aware of the material disadvantages of a virtual shareholding compared to a real one – in particular, the lack of information, control and property rights that real shareholders would have. A holder of virtual shares is not entitled to dividends or annual reports, for example, and has no voting influence on company management. Employees also bear a risk when it comes to dilution: employee participation agreements do not usually contain any protection against dilution. This means that if new investors receive shares in financing rounds, the percentage share held by employees decreases accordingly without compensation. This can be particularly problematic in down rounds, i.e. financing rounds with a lower valuation: here, professional investors often secure anti-dilution clauses (e.g. full ratchet) that protect their quota, while the shares of the other shareholders – including employees – are diluted disproportionately. In other words: In difficult times, employee shares are usually at the bottom of the ranking. Another practical risk is the complexity of the contract: VSOP contracts are legally and mathematically complex, which can be difficult for laypeople to understand. Unfavorable clauses (such as strict bad leaver provisions, see below) could result in an employee losing their participation when the employment relationship ends – even after years of service. Last but not least, it must be emphasized that work for equity should not be a substitute for a living wage: If an employee works for a startup for (almost) no pay for an extended period of time, they bear a considerable financial and personal risk. In Germany, such an agreement may also be legally invalid (minimum wage issue, see below). Overall, the decision to engage in work for equity entails considerable risks for employees – they should only be taken if you are convinced of the success of the start-up and can afford the risks.
• For founders/companies: Even from a company perspective, employee participation is not a sure-fire success. Administrative complexity is a key issue: with genuine shares, notary appointments, commercial register entries and company law formalities must be complied with. Many (small) shareholders mean more coordination effort – resolutions can become more cumbersome and every change (entry/exit of an employee) requires changes. Even with virtual programs, the contractual effort should not be underestimated: Individual participation agreements or plan terms need to be drawn up and communicated with each employee. In addition, there are costs for legal and tax advice in order to set up a legally compliant program and avoid pitfalls (e.g. payroll tax issues, 409A valuation for US options, etc.). There is a major risk if the legal structure is ineffective – for example because a vesting clause violates applicable law or an equity agreement undermines the minimum wage. There is then a risk of costly disputes or additional claims later on. Another disadvantage can be the dilution of the founders’ shares: Every equity stake issued to employees reduces the percentage share held by the founders (with capital otherwise remaining constant). Although this is intentional and ideally value-enhancing, founders must be careful not to lose control. Particularly if no vesting has been agreed, it can happen that an employee who joined the company early on still holds shares after leaving – these unproductive minority shareholders can make later decisions or financing rounds more difficult. Such constellations are a red flag for future investors. Investors generally want the cap table to be “tidy”: all existing shareholders – whether founders or employees – should be subject to vesting or have their shares bundled so that investors do not have to negotiate with dozens of parties. If this is not the case, it can deter willingness to invest. Finally, from an employer’s perspective, it should be mentioned that the motivation provided by equity participation can also be overestimated: If the exit event is in the distant future or seems unlikely, the incentive may fizzle out on a day-to-day basis. Employees may react with frustration if the expected added value from the shares does not materialize. Participation is therefore no substitute for a good management and communication concept, but must complement it.

In summary, work for equity offers great opportunities – particularly as a competitive advantage in the “war for talent” – but also harbors considerable risks for both sides. An honest explanation of the opportunities and risks is essential so that all parties involved can make informed decisions. The next step is to clarify which legal framework conditions must be observed when using work for equity in Germany.

Legal framework: Labor law vs. corporate law

Work for equity particularly raises questions about the distinction between employment and partnership. On the one hand, work is performed, but on the other hand (in some cases) no monetary remuneration is to be paid for this, but rather an equity participation. This affects key protective standards under employment law as well as company law requirements for the shareholding structure. The most important framework conditions are outlined below.

Labor law aspects

Remuneration and minimum wage: As a general rule, employees have a statutory right to remuneration. An employment contract that provides for no or disproportionately low remuneration violates the core of labor law (Section 611a (1) BGB requires the agreement of remuneration) and, if applicable, morality (Section 138 BGB). In particular, the statutory minimum wage must be observed in Germany (currently €12 per hour, as of 2023). The Minimum Wage Act (MiLoG) applies to all employees – even in start-ups, there is no exception whereby salary can simply be replaced by equity. Any underpayment of the minimum wage makes the employer liable; the difference can be claimed from the employee, a waiver is excluded by law. A contract that provides for pure gratuitousness would therefore be null and void in accordance with Section 134 BGB if it violates MiLoG. The obligation to pay wages can only be waived in narrow exceptional cases, namely if the person is not considered an employee in the sense of employment law. For example, managing partners of a GmbH are not employees and are therefore not entitled to a statutory minimum wage. A founder who is both managing director and (co-)owner may therefore formally pay himself a low or zero euro salary without violating MiLoG. The same applies to genuine co-entrepreneurs (e.g. partners in a partnership) who do not have a dependent employment relationship by virtue of their shareholding. However, caution is required here: Not every designation as “partner” or “co-founder” protects against classification as an employee if the actual circumstances suggest a personal dependency. This is referred to as bogus self-employment or a bogus employment relationship. Especially if someone only holds a small share, has no blocking minority and no management function, but works full-time for the start-up like a normal employee, there is a risk that courts will nevertheless consider them to be an employee – with the result that all employee protection laws (protection against dismissal, vacation entitlements, MiLoG etc.) apply and the equity agreement could be treated as a circumvention in the event of a conflict. In practice, attempts are made to counter this risk by only making genuine equity deals with core team members who either have founder status themselves or at least receive an appropriate fixed salary in addition. In Germany, purely equity-based cooperation is basically only permitted for board members or genuine shareholders. It should also be noted that a company share granted to an employee in return for a salary waiver can be considered part of the remuneration under employment law – any subsequent removal of this share (e.g. through withdrawal in the event of termination) could then be considered a salary reduction or contractual penalty if there is no effective agreement. Employment law and dispositive company law meet here, which is why the contracts must be very carefully balanced.

Working hours and social security: Even if the main focus is on the salary, some peripheral aspects deserve to be mentioned. An employee who works for Equity is generally still subject to social security contributions (unless they are listed as a self-employed consultant or similar, which carries the risk of bogus self-employment). The payment of social security contributions is then based on a fictitious amount or the minimum wage in the absence of a salary. In addition, working time laws, vacation entitlements, etc. apply unchanged. The startup can therefore not argue that the employee is “voluntarily” working longer without a salary – overtime regulations remain applicable. Overall, the protective provisions under labor law are mandatory: they cannot be waived by giving the employee shares. Therefore, a work-for-equity model must always comply with employment law – either by changing the employee’s status (making them a co-partner, see above) or by paying them at least the minimum wage and granting them an additional share.

Corporate law aspects

Formal requirements and capital measures: As soon as real company shares come into play, company law comes into play – in start-ups typically GmbH law (GmbHG) or, more rarely, stock corporation law (AktG). In the case of a GmbH, it should be noted that the transfer of shares requires notarization in accordance with Section 15 GmbHG. This means that every employee who is to receive a GmbH share must either be included in the founding act or must later be given a share in the company by means of a notarized assignment agreement. Alternatively, a capital increase can be carried out in which new shares are created and taken over by the employee – this also requires notarization of the shareholder resolution and entry in the commercial register. In practice, it is time-consuming (and expensive) to incorporate many small shareholdings in a GmbH. In addition, all shareholders have certain rights under the GmbHG that cannot be easily excluded. For example, every shareholder has a right to information and inspection in accordance with § 51a GmbHG, and important resolutions (e.g. amendments to the articles of association, capital increases, sale of the company) require qualified majorities (75% in accordance with § 53 II GmbHG). Numerous small shareholders can therefore at least theoretically complicate the passing of resolutions – for example, if individual shareholders cannot be found or vote against measures contrary to expectations. For these reasons, attempts are often made to contractually restrict the co-determination rights of employees in the case of genuine shares, e.g. by suspending their voting rights in the articles of association or reducing them to certain core rights. However, this comes up against the limits of the law and must be very carefully formulated (so as not to become ineffective as a gagging clause ). It is usually easier to involve employees without voting rights (e.g. via silent partnerships or profit participation rights), but this in turn can be less attractive.

Aktiengesellschaft vs. GmbH: Some start-ups are considering setting themselves up as an AG (or European SE), as stock corporation law offers more flexible instruments for employee participation. In particular, share options can be made possible via so-called conditional capital: The company creates a pot of potential shares in the articles of association that may be issued to employees without having to bring about an AGM decision every time. The Future Financing Act planned for 2023 will increase this limit for conditional capital from 10% to 20% of the share capital, which will make ESOP programs much easier. In the case of shares, it is also easier for employees to join at a later date, as the transfer (at least of registered shares with restricted transferability) does not require a notarial form, but is simply possible by endorsement/contract. However, the legal form of an AG also has disadvantages in the early phase: it requires a high share capital (€50,000), ongoing publicity and formal obligations (annual financial statements in the Federal Gazette, general meeting, possibly a supervisory board with 3 or more members on the management board, etc.). For many small start-ups, the overhead of an AG is too great. This is why a compromise solution is often chosen: The company remains a GmbH (or UG) for the time being, and the employees receive virtual shares. If the company grows or aims for an exit (IPO), it can still be converted into an AG at a later date in order to issue real shares.

Pooling structures: In order to overcome the disadvantages of having many direct shareholders, some start-ups use a trick: they interpose an investment company that pools the employee shares. A popular model is the Mitarbeiterbeteiligungs-KG (more on this below), in which the employees join a GmbH & Co. KG as limited partners and this KG then holds an interest in the main GmbH as a unit. Trust structures are also conceivable in which, for example, a trustee (such as a lawyer or a management GmbH) holds the shares in trust for the employees. Such pooling models facilitate administration, as internal (in the pool) additions and disposals of participants can be regulated relatively flexibly, while only one shareholder acts externally vis-à-vis the main company. In any case, it is important that clear agreements on rights and obligations are made where there are several participants: These include, in particular, pre-emption rights, drag-along/tag-along regulations(co-sale rights or obligations) as well as exit and valuation modalities. Ideally, these are set out in the articles of association (in the case of direct participation) or in a participation agreement. It should also be borne in mind that genuine employee shareholders may come closer to the threshold under company co-determination law (keyword BetrVG and threshold number of employees for works council etc.), although this is rarely relevant in small start-ups.

Combination with employment contracts – slicing pie concept: The “slicing the pie” concept, which has also recently attracted attention in Germany, deserves special attention. This is a dynamic participation model in which participation quotas are continuously adjusted according to actual contributions made (working hours, money contributed, benefits in kind, etc.). It is effectively a time account: Everyone who works or invests for the project collects “slices” (points), and the relative number of these points determines the share in the company at any given time. This system is intended to ensure a perfectly fair distribution of equity, as it is based on the respective risk contributions. In legal terms, however, this is treading on thin ice. In practice, slicing-pie models are often implemented using a mixture of a pre-founding company (GbR) and subsequent transfer of shares. For example, several people conclude a contract that initially provides for cooperation as a GbR and each acquires a relative share according to the slicing pie formula. As soon as a certain milestone is reached (e.g. market maturity or initial financing), the distribution earned up to that point is “frozen” and converted into real shares in a newly founded corporation. Such contracts combine elements of the employment contract, partnership agreement and even license agreement (for example, if rights are granted to ideas/IP that have been contributed). The challenge is that until a company is formally established, it is often legally a GbR – which means that all parties involved could be personally liable. There is also the risk that the authorities will consider these structures to be a circumvention of a regular employment relationship, especially if there is actually an employer-employee relationship. The German laws against bogus self-employment and illegal employment were recently tightened again in 2019. Slicing-pie contracts must be drafted with corresponding caution: It should be clear that all parties involved are co-founders at their own risk, otherwise there is a risk of social security contributions or back pay afterwards. Such models are often used in an early, pre-seed phase and end as soon as investors join – from then on, fixed participation quotas apply again. Overall, slicing pie offers maximum flexibility, but numerous legal pitfalls in labor, social security and corporate law. Such a contract should not be drawn up without qualified legal advice, as the liability risks are considerable. In Germany, this is a gray area between anticipated company formation and bogus employment. Therefore, this concept (still) remains an exception, whereas in the USA – where employment law is handled much more liberally – slicing pie is more popular.

Contractual implementation and typical clauses

The successful implementation of employee participation stands and falls with a clean contractual structure. On the one hand, individual solutions are required, while on the other, certain standard clauses have become established to regulate typical scenarios. Some of the most important contractual mechanisms are explained below:

Vesting and reverse vesting

Vesting refers to the concept that shares must first be “earned” over a certain period of time. Instead of an employee immediately holding 5% of the company for good, it is agreed that they will only keep this share if they remain with the company for at least four years, for example. Vesting periods of 3-5 years are common, often with a cliff period at the beginning (e.g. 1 year) during which nothing is vested. Only after the cliff has expired does a first block vest (e.g. 25% after 1 year) and then the remainder on a monthly or quarterly basis. If the employee leaves the company before the end of the vesting period, the unvested shares are forfeited – in other words, the employee only retains the percentage already acquired. The aim is to create an incentive for long-term loyalty and at the same time protect the company: Those who leave early should not benefit in the same way as someone who has spent years building up. Vesting has been standard practice in Silicon Valley for decades and has also found its way into Germany, particularly in VSOP plans (where employees “earn” their virtual shares over time). For founders and investors, vesting is almost indispensable to avoid the worst-case scenario of a co-founder or early employee leaving with a large stake and leaving the company with nothing but a motivational hole.

Reverse vesting applies the principle specifically to founders. Since founders usually divide 100% of the shares among themselves at the beginning (before employees and investors join), the shares cannot be allocated to them in installments. Instead, all founders receive their shares in full at the start, but undertake in the shareholder agreement to retroactively lose or return these share rights if they leave the company before the vesting period expires. In practice, this is usually done via call options in favor of the co-founders or the company: if a founder leaves early (e.g. termination of the managing director’s employment contract within 36 months), the remaining shareholders have the right to buy out a defined portion of their shares at nominal value or a low price. In this way, his shareholding shrinks in line with the vesting period not “served”. This procedure ensures that fairness also prevails among founders – those who contribute less (because they leave early) end up holding fewer shares. For investors, such a clause is often a condition for entry. However, reverse vesting clauses must be carefully formulated in order to be legally tenable (see below on the problem of the prohibition of termination).

Good leaver/bad leaver: In practice, vesting rules are often combined with leaver clauses. These differentiate between the reasons for leaving. A bad leaver is, for example, someone who resigns of their own accord or is fired for good cause (due to conduct). A good leaver, on the other hand, leaves e.g. due to long illness, death, termination for operational reasons or by neutral means (by mutual agreement after a certain period of time). Depending on the case, different legal consequences are agreed: A bad leaver often also loses shares that have already been vested (or must return them at nominal value), while a good leaver may at least keep the acquired share or have it settled at market conditions. This differentiation is intended to prevent someone from behaving disloyally and still being rewarded or, conversely, to ensure that those who leave through no fault of their own are rewarded fairly. However, excessively strict bad leaver clauses that punish an employee excessively can be classified as invalid in labor court reviews of general terms and conditions (keyword: disproportionate contractual penalty). A sense of proportion is required here.

Legal admissibility of vesting: A critical legal hurdle for vesting clauses for genuine shares is the so-called prohibition on dismissal under company law. According to established case law of the BGH, shareholders of a GmbH may not be forced out of the company by majority resolution simply because, for example, the employment relationship ends. The shareholder position is legally independent of the employment contract – the end of employment does not automatically justify the withdrawal of the ownership position. However, vesting essentially amounts to allowing shares to “lapse” if someone no longer works for the company. This is where the investor-friendly vesting agreements collide with the protection of the GmbH shareholder. For a long time, it was unclear whether and how vesting can be effectively agreed in German articles of association. The solution lies in a contractual arrangement as an option right instead of an automatic forfeiture. This means that the shareholder in question initially receives all shares, but is contractually obliged to submit an offer to buy back the (unvested) shares at a predetermined low price in the event of withdrawal (or to accept such an offer from fellow shareholders). Technically, this is not a unilateral “ejection”, but an acquisition process that is contractually regulated in advance. This structure can nevertheless be problematic, especially if the departing founder has actually already made significant contributions and is then left virtually empty-handed. The discussion reached a new milestone in 2024: In an advisory decision dated 12.08.2024 (case no. 2 U 94/21), the Berlin Court of Appeal indicated that vesting regulations in start-ups should be assessed more generously. It created new leeway to the effect that, under certain conditions, such a withdrawal of shares can be compatible with the duty of loyalty under company law without violating the BGH doctrine. Specifically, the case concerned an agreement between founders that provided for reciprocal purchase and sale offers in the event of withdrawal – this was deemed permissible by the KG. However, caution is still required: The exact effectiveness depends on the balanced design in the individual case, and clarity from the Federal Court of Justice is still pending. In practice, vesting clauses should always be well justified (protection of a legitimate company interest) and leave the departing party with at least adequate compensation for contributions already made in order to withstand a judicial review of their content.

Anti-dilution (protection against dilution)

Anti-dilution clauses serve to protect a shareholder against loss of value or quota due to subsequent capital measures. In the venture capital context, such clauses in favor of investors are common – for example in the form of full ratchet (investors are treated as if they had invested at the low new price in the event of a downturn) or weighted average (adjustment of the price basis according to average value). In contrast, anti-dilution rights are almost always excluded for employee shareholdings. The reason is obvious: start-ups must be able to raise new capital flexibly without having to renegotiate with every virtual shareholder. If employees were guaranteed to always participate in capital increases or be compensated, this would deter investors and further dilute existing shareholders. For this reason, VSOP agreements regularly stipulate that issuing new shares to investors reduces the relative participation rate of employees accordingly, without compensation(virtual employee participation in start-ups). For the employee, this means that their percentage share of the exit proceeds may fall if new financing rounds take place in the meantime. Example: If an employee is entitled to 1% of the exit proceeds and a financing round is added that takes 20% from the existing shareholders, their share will fall to 0.8% (unless special regulations apply). Note: Not every capital measure justifies the complete waiver of dilution protection. In extreme cases, one could consider safeguarding certain measures – e.g. a split or certain conversions – but in practice, protective clauses are usually limited to the investor side. Employees should at least be aware that investors often have their own dilution protection in down rounds, shifting the burden of loss unilaterally to founders and employees. A fair arrangement could be to issue additional virtual shares to employees in the event of serious dilution in order to maintain motivation (however, this decision is at the discretion of the management and the shareholders’ meeting). All in all, anti-dilution clauses tend to be the exception in work-for-equity deals. Instead, a sufficiently large pool of employee shares is often defined at the beginning (e.g. 10% of the capital), which is then distributed among several employees, whereby future dilutions affect all of these shares together.

Other important contractual clauses

Exit regulations and liquidation preferences: Employee participation agreements – especially VSOPs – should clearly define how the participation is calculated in the event of an exit. The payment claim is often based on the net sales proceeds after deduction of certain costs and liquidation preferences of the investors. Investors often receive upfront payments (liquidation preference) in participation agreements, e.g. their invested capital plus X% interest, before the remainder is distributed to everyone. In a fair program, this order is also applied to virtual shares: I.e. only when the (contractually defined) revenue preferences have been serviced do the virtual units participate in the remaining surplus. Example: If it is agreed that in the event of a partial sale (e.g. 80% of the company), the employee will only receive a pro rata share, in which case he will receive 80% of his arithmetical entitlement and retain a virtual share of 20%. Such detailed clauses are important in order to avoid disputes later on. Settlement mechanisms should also be regulated: Some programs allow the company to pay out an employee before the exit and thus remove them from the program. This can be useful if, for example, an employee leaves before the exit – instead of “parking” them until the exit, the company can buy out the entitlement they have built up until then (divesting in return for severance pay). However, this option should be fairly structured (usually at the market value of the virtual shares, if determinable) and ideally only exercisable unilaterally by the employee so that the company does not buy out the workforce on the cheap shortly before a major exit.

Drag-along / tag-along: If employees hold real shares (whether directly or indirectly via a KG), co-sale rights and obligations must be agreed. A drag-along clause ensures that in the event of a company sale (share deal), all shareholders must also sell if a defined majority does so. Without a drag-along, a minority shareholder could block the sale by not wanting to sell his shares – an exit would then be jeopardized. It is usually stipulated that, for example, the majority of shareholders (including investors) are entitled to force the minority to sell on the same terms. This also creates clarity for employees: they know that if the sale is successful, they will also exit and not remain as shareholders in a company that has been sold. In return, a tag-along (co-sale right) is relevant so that minority shareholders are treated equally if the majority shareholders sell their shares. In practice, tag-along means that if the founders/investors find a buyer for their shares, the employees have the right to sell their small shares at the same conditions. This prevents a buyer from only purchasing the profitable large packages and leaving the smaller shareholders behind. In the case of virtual programs, this question does not arise directly, as the employees do not hold any real shares – however, it should be contractually regulated that in the event of an exit, the claims automatically become due and the program ends.

Non-compete clauses and retention clauses: Some companies add post-contractual non-compete clauses to equity agreements. In the case of high-tech start-ups in particular, the aim is to prevent an employee with acquired know-how from immediately moving to a competitor. In Germany, such clauses are only permitted in return for payment of compensation for non-competition (Section 74 (2) of the German Commercial Code (HGB) also applies to non-agents). The question often arises as to whether the participation itself can serve as sufficient compensation for a non-competition clause – as a rule, it cannot, since the compensation must be measured in monetary terms. Nevertheless, employees can be obliged to enter into ongoing non-competition agreements (for the duration of their employment) and violations can be sanctioned with the loss of shares (e.g. bad leaver clause in the event of poaching attempts or similar). Such clauses must be very clearly defined and reasonable in order not to be rejected as disproportionate.

Contractual documents and samples: Implementation usually takes place in several documents. The core is either the employment contract with a participation clause or a separate participation agreement. In the case of real shares, the articles of association of the GmbH are often supplemented accordingly (by vesting/pre-emption right clauses) and the employee concludes an accession agreement. In the case of virtual shares, there is often a framework agreement (plan) that sets out the conditions for all participants and individual allocation agreements with each employee. Numerous sample formulations are in circulation – for example from the Federal Association of German Startups or from publications by law firms. For example, there are standard clauses for vesting periods or good/bad leavers. Nevertheless, adjustments are usually necessary to take account of the specific circumstances. Every start-up cap table is different, and the position of the employee (C-level vs. simple engineer) may also require adjustments. It is important that all agreements made are set out in writing and as clearly as possible. Verbal promises such as “You’ll get your share on exit” are dangerous, as they are non-binding in case of doubt. Overlaps between employment and partnership agreements should also be dealt with: If, for example, the vesting period is mentioned in the employment contract, it should be consistently regulated in the partnership agreement to avoid contradictions. Finally, such contracts should grow dynamically: when new investors come on board, they often want changes (e.g. adjustment of the pool). It is therefore advisable to formulate clauses flexibly or provide for amendment options so that the shareholding program can be adapted to new circumstances without having to ask each employee for separate consent.

Role of those involved: founders, investors and employees

When it comes to work for equity, different interests and perspectives sometimes clash. It is helpful to take a closer look at the role of the individual parties involved in order to understand typical conflicts and solutions:

Founder perspective

Employee participation is a double-edged sword for founders. On the one hand, it offers the opportunity to bring talented employees on board, even though they cannot (yet) be paid a standard market salary. Particularly in sectors with a shortage of skilled workers, a share offer can make the difference between a top candidate switching to an unknown start-up or accepting an offer from a large corporation. It also promotes loyalty: employees with equity are more likely to think and act in the interests of the company, which takes the pressure off the founders. On the other hand, founders must be prepared to give up a piece of their own pie. This requires trust: Trust that the employee will actually contribute to the success and stay, as well as trust in fair cooperation. Founders would do well to have a well-thought-out participation concept before handing out shares carelessly. It is often recommended to plan a certain pool (e.g. 10-15%) for employees from the outset and to include this reserve in the cap table so that later dilutions do not come as a surprise. Founders should also ensure that they comply with vesting rules themselves in order to set a good example: If investors see that the founders are also vesting equity, this signals commitment and fairness within the team.

One potential point of conflict is the power imbalance: Founders usually hold the lion’s share of the shares and have the upper hand when it comes to decisions. You should avoid giving shares as a mere lure and then keeping employees away from key information or decisions. While it is legitimate to retain control, transparent communication is crucial to ensure that the shareholding fulfills its purpose. In practice, this means regular updates on the company’s progress, involving employees (at least informally) in strategic considerations and valuing their position as co-owners. Founders also have to learn to deal with complexity – initially equity is an abstract promise, but later it becomes real: cap table management, dilution calculations, valuation issues for tax purposes, all of this comes their way. Last but not least, founders are responsible for complying with legal requirements. Omissions (such as a breach of the minimum wage or errors in contract drafting) can be expensive and endanger the young company. Overall, founders should use work for equity strategically: As an investment in team culture and retention, not merely as a stopgap solution due to lack of money. If employees feel that their contribution is taken seriously and fairly remunerated – even if it is “only” in shares – this pays off in terms of motivation and company growth.

Investor perspective (business angels, VCs)

Investors assess employee participation primarily in terms of value enhancement and risk minimization. Many VCs consider a well-constructed ESOP/VSOP program to be a quality feature of a start-up: it shows that the founding team has understood the importance of employee incentives and was prepared to set aside equity for this purpose. In fact, investors often actively request the establishment of a specific option pool in the course of a financing round. It is not uncommon for the term sheet to stipulate that, for example, 10% of the shares are to be made available as a pool for (current and future) employees – usually “pre-money”, i.e. at the expense of the existing shareholders. In this way, investors ensure that enough shares are available for future hires after they have joined the company without their own shareholding subsequently dwindling.

Investors also make sure that existing and future employee shareholdings are organized and limited. A horror for VCs would be a cap table with dozens of small shareholders without vesting – here they see problems with future decisions or exit transactions. Investors therefore often demand that all existing employee shares are vested or that existing shareholders (founders or employees) return unwanted shares or transfer them to a pool before financing. Investors also insist on professional contractual clauses: Drag-Along, Tag-Along, clear anti-dilution provisions (in favor of investors) and no veto rights for minority shareholders that could hinder the investor. In particular, employees should not be given any special veto or approval rights in shareholder agreements that go beyond their voting rights. It is also usually required that employee shares are made non-voting or that employees tie their voting rights to the founders/investor-friendly voting agreements – to ensure that the voting remains with the main shareholders.

Another point: company form and tax. International investors like to see an investment that is “clean” – i.e. no impending tax problems. An ESOP in a US delaware corp, for example, is tried and tested and tax-clear (options are valued in accordance with §409A IRC, employees only pay tax on exercise/sale). In Germany, the equivalent was blurred for a long time – virtual options were considered not perfect by investors, as it was unclear, for example, whether tax side effects would occur in the event of an exit or whether employees could possibly position themselves as quasi-creditors. However, a lot has happened here; new legal regulations (see Future Financing Act) and precedent from larger exits have created standards. Nevertheless, some investors prefer start-ups that operate as a stock corporation with a genuine ESOP because this corresponds to the usual international model. This is where philosophies often clash: traditional German investors have come to terms with the GmbH+VSOP, while international VCs sometimes push start-ups in the direction of a “flip to Delaware” or at least a German AG in order to set up an ESOP. Business angels who invest in the very early stages are usually somewhat more flexible, but also demand that key team members are appropriately incentivized.

In summary, investors expect employee participation as a motivational tool, but only in a form that is structured in an investor-friendly way: with a sufficiently large but limited pool, with vesting/cliffs, without unusual protection for the employee shares and preferably with simple handling (e.g. bundled in a limited partnership or as non-voting shares). Ultimately, the program should make the company more valuable, not more complicated. A positive-minded investor may even help to expand the program – for example, by releasing further options at a later date – if this helps performance. But investors will also make sure that employee participation does not become a dilution trap for the founding team: After all, a founding team that is too diluted loses motivation in turn. It is therefore also important to find the right balance here.

Employee perspective

For employees – especially those who are about to make the decision to switch to a startup – work for equity is often uncharted territory. Their perspective is characterized by the trade-off between security and opportunity. On the plus side, there is the prospect of profiting disproportionately if successful and perhaps experiencing an entrepreneurial breakthrough that is not possible in normal white-collar jobs. On the debit side are salary sacrifices, a higher risk of failure and uncertainty as to whether the promise can be kept. Employees therefore ask themselves a few key questions: Is the equity offer fair – i.e. does it sufficiently compensate for the low salary in expected value growth? How high is my percentage share, and how much could this mean in monetary terms if the startup reaches common milestones (e.g. Series A, Series B, exit)? What are the conditions? – Does the vesting plan provide for too long a period? Is there a cliff where I get nothing in the first year, what happens if I leave the company before an exit? A responsible startup will create transparency here and explain the mechanisms to the employee. For example, with calculation examples, scenarios and clear documentation.

Employees should also pay attention to the contractual details: Is their participation tied to the continuation of their employment contract? (Usually yes: termination leads to the loss of non-vested shares.) What happens in the event of dismissal – do you become a bad leaver and lose everything? Can the founders unilaterally change the program (e.g. issue more virtual shares, which dilutes my shareholding)? Not every employee is legally savvy, but it’s worth asking about these points. Sometimes professionals consult lawyers to review offers, especially for higher positions. In Germany, the concept is not yet as widespread as in the USA, so there is a certain need for clarification.

From the employee’s point of view, it is also relevant: What position do I actually have as an employee? Do I receive regular information about the company’s development (e.g. annual reports)? Am I involved in important decisions or at least informed in advance (e.g. about an upcoming financing round that dilutes my shareholding)? Virtual participants in particular have no such formal rights(virtual employee participation in start-ups). Therefore, a lot has to be based on trust. A startup that regards its employees as “co-entrepreneurs” will treat them more openly internally – for example, giving quarterly updates, openly discussing the equity issue – while others may communicate the minimum. Here you can find out what the company culture is like.

Another aspect: exit strategy and personal risk. An employee in their twenties without family burdens is more likely to be able to afford to work towards an exit opportunity for two years for a low salary than someone with a family or financial obligations. That’s why everyone has to check for themselves how much salary sacrifice is acceptable. In some cases, alternative solutions are sought, e.g. initially working part-time for equity (and keeping a bread-and-butter job at the same time) or a mixture of salary and equity (such as a lower fixed salary plus shares). As mentioned, the legislator sets limits on total renunciation anyway (minimum wage). However, employees could also argue morally: An equity-only offer that effectively amounts to below minimum wage should be rejected unless it is accompanied by genuine founder status and correspondingly high equity (20% and more). An often quoted guideline among founders is: anyone who works without a salary is actually a co-founder – anything else would be unfair. Accordingly, the equity should be in proportion. For example, 0.5% would probably be too low for an early employee who forgoes most of their salary for years, while 5-10% might be more appropriate depending on the position and stage. Ultimately, it depends on the industry, value contribution and team size – there is no such thing as absolute fairness, but transparency and honest negotiation can help to put together a mutually acceptable package.

Company form and structure: Advantage of a GmbH & Co. KG?

As mentioned above, the choice of company form can have a significant impact on the implementation of employee shareholdings. In particular, the construction of a GmbH & Co. KG as an investment company has emerged as an elegant way of enabling genuine shareholdings without making the main company unwieldy.

In the case of the so-called Mitarbeiterbeteiligungs-KG, the participants establish a limited partnership alongside the actual startup GmbH. Typically, the startup GmbH itself (or a UG/GmbH controlled by the founders) acts as the general partner (managing partner) of the KG. The limited partnership shares are initially held by the startup GmbH as the sole limited partner (so that the KG holds 100% of the GmbH). This KG serves as a pool for the employee shares. From then on, employees can be gradually added to this limited partnership by the startup GmbH transferring its limited partnership shares to the employees one by one. Each employee thus becomes a limited partner in the employee KG and acquires a share in the KG, which in turn holds shares in the main GmbH. This means that they effectively have an indirect stake in the GmbH without the GmbH itself constantly acquiring new shareholders.

The advantages of this model are manifold: Simpler transfers – The entry of a new limited partner into the KG only requires a shareholder resolution and an application to the commercial register with a notarized signature, but no notarization of each transfer transaction. In particular, GmbH shares do not have to be notarized for each employee shareholding, which saves time and costs. The KG can be “filled” at the beginning with all shares intended for employees (by a one-off assignment/contribution of the GmbH shares to the KG, notarized). The distribution is then regulated internally via limited partnership shares – this can be done informally by contract between the KG partners. Bundling of votes – In the main GmbH, the KG acts as a single shareholder. The employees only vote within the KG on their behavior in the GmbH, or the management of the KG (typically the founders as general partner managing directors) decides according to a procedure defined in the KG agreement. This keeps the cap table of the GmbH lean: regardless of whether 1 or 20 employees are involved, there is only one additional shareholder (the KG) from the perspective of the GmbH. Investors therefore only have to consider one additional player in case of doubt. Flexibility in the structure – The KG partnership agreement can contain vesting and leaver provisions that take the special features into account. For example, it can be agreed that if an employee limited partner leaves, he transfers his KG shares back to the startup GmbH or the founders (quasi vesting within the KG). Different profit distributions can also be defined – e.g. that the KG profits (which come from profit distributions from the GmbH) are distributed to the limited partners according to a certain formula. It is also possible to ensure that employees have no influence on the management of the KG (limited partners are excluded from management by law, § 164 HGB), and the general partner (the founders via the GmbH) remains in charge. This gives employees an economic stake without relinquishing control.

Another advantage is of a tax nature: In a KG, the limited partners are co-entrepreneurs and earn income from business operations, whereas virtual shares are subject to income tax. However, this area is complex – there are allowances for employee shareholdings, differences in taxation upon receipt, etc. As we are only touching on tax aspects here, it should be noted that the KG solution can also be made attractive from a tax perspective if, for example, shares are initially granted at nominal value and the increase in value is then realized later as a capital gain.

The disadvantages of the KG structure are the initial outlay and somewhat higher ongoing compliance costs: you need an additional company (i.e. KG agreement, registration with the commercial register, etc.), there may be two annual financial statements (for GmbH and KG), and more parties are legally involved. For very small teams, the effort is not worth it – a simple VSOP will do. But as soon as a company plans to involve several employees over the years and give them real equity, an employee KG can be advantageous. In Germany, for example, it is used by start-ups that want to retain many former employees in the company while maintaining investor compatibility. One example is SkySails GmbH, which has set up a “SkySails Mitarbeiterbeteiligungs KG”.

To mention briefly: Alternatively, you could also set up the entire start-up as a GmbH & Co. KG, in which employees become limited partners directly. However, this model is rarely chosen, as the founders would then have unlimited liability as general partners (or you would need a GmbH as general partner, which would then lead back to the above model). In addition, the withdrawal and tax regulations in a partnership are too confusing for many founders. Therefore, the separation usually remains: the operating company as a GmbH, and a separate KG as a pool.

In conclusion: The choice of company form is a strategic decision. For early phases with uncertain development, a simple GmbH/UG with VSOP offers the most flexibility and lowest costs. In later phases or if you are thinking internationally, an AG can make sense in order to involve employees through genuine share options. The GmbH & Co. KG as an employee pool is a creative German solution that combines many advantages, but also means more initial effort. Start-ups should examine these options – often in consultation with investors and legal advisors – in order to find a structure that is both legally compliant, practicable and attractive for employees.

International models and transferability

A look abroad – particularly in the USA – shows how employee participation can be structured as an alternative and where the limits of transferability to Germany lie. In the USA, an Employee Stock Option Plan (ESOP) is part and parcel of every start-up. Employees there typically receive options on company shares that vest over four years (with a one-year cliff) and which they can exercise on leaving the company or at the latest on exit. These options entitle them to purchase shares at a predetermined strike price (often very low in the early stages, close to the nominal value). In the event of a successful exit, the market price of the share is then far higher than the strike price, so that the difference represents the profit for the employee. Alternatively (especially when the company is sold), the options are often directly cash-settled, i.e. the employee receives the value without actually having to buy shares. It is important to note that even in the USA, normal employees rarely work for no salary at all. As a rule, they receive a basic salary – albeit often below the market – plus the prospect of becoming rich through options. Legally, there is also a minimum wage in the USA (federal minimum wage, plus possibly higher in California etc.), and there is no general exception for start-ups to pay employees in shares instead. However, founders and early key employees are often classified as “founders” or “executives” and receive a token salary (e.g. $1 per year or very little), which is practically condoned as long as no one sues. The labor law climate is much more business-friendly due to at-will employment and weaker protection against dismissal, which favors such informal solutions. Nevertheless, there have also been cases in the US in which former employees have sued for retroactive pay when the startup failed and the promised options remained worthless – very similar to what is conceivable in Germany.

What works better in the USA is the tax and regulatory system: there are established valuation procedures (409A) to set the fair market value of start-up shares at a low level so that employee options do not trigger any immediate tax. In addition, US tax law recognizes concepts such as Qualified Small Business Stock (QSBS), which exempts profits of up to USD 10 million from tax if real shares are held for 5 years, which benefits founders and employees alike. Such regulations are largely absent in Germany or were insufficient until recently (the German tax-free allowance for employee stock ownership was only increased from €360 to €1,440 in 2021, still marginal compared to US volumes). However, German lawmakers have recognized that the country will fall behind in the competition for talent and start-ups if it does not keep up. With the Fund Location Act 2021 and the planned Future Financing Act 2023/24, steps have been and are being taken to make employee participation more attractive. For example, tax disadvantages (dry income) are to be mitigated through tax deferrals and more flexibility is to be created for share options. In particular, as mentioned above, the Future Financing Act plans to improve the framework conditions for genuine ESOPs (increase in conditional capital to 20%, taxation of employee shares only on exit under certain conditions, etc.). This paradigm shift is based on Anglo-American models and could make it easier for German start-ups to adapt US models.

Nevertheless, cultural differences remain. In the US, it is almost expected that a start-up employee has stock options; salary negotiations often revolve around equity as much as salary. In Germany, the idea of giving up salary to gamble is alien to many employees. The need for security is higher, partly due to the dense social network and the traditional work culture. A founder in Germany who proposes “We won’t pay you anything for now, but you’ll get 5% of the company” is likely to be met with skepticism – and this is justified from a legal perspective, as a zero salary is generally not permitted by law (minimum wage). In the USA, on the other hand, this is almost romanticized among start-up enthusiasts, but even there it is often practically solved by founders’ shares instead of real employment contracts without pay.

Another international point of comparison: in many European countries there are special employee participation programs, e.g. the EMI (Enterprise Management Incentives) in the UK, which enables tax-privileged options, or models in France (BSPCE) with employee options that are also tax-incentivized. These models all pursue the goal of allowing employees to participate in the company’s success without the disadvantages mentioned above (tax before liquidity, excessive formalities). Germany is slowly catching up here. For start-ups that are internationally active or have teams in different countries, however, this means that they may have to run several programs in parallel – e.g. a VSOP for German employees, an EMI for British employees, etc. This naturally increases complexity. This naturally increases complexity.

In summary, it can be said that international role models show that employee participation can be a success factor if the framework conditions are right. Many mechanisms (vesting, option pools, etc.) have been adopted from the USA and can in principle also be applied in Germany – they just need to be adapted to local law. What cannot (yet) be implemented in Germany is an extreme “sweat equity” model, where regular employees work for equity completely without pay – the legislator sets limits here (and that is a good thing, to avoid exploitation). However, the trend is towards making these forms of participation more comparable internationally by removing legal hurdles. For example, the Future Financing Act promises that start-ups and scale-ups will be able to attract and retain talent more easily in future because sustainable employee participation programs will be less risky and will no longer rely solely on unofficial aid constructions. In a few years’ time, it could therefore be much more natural for German employees to receive part of their remuneration in equity – flanked by laws that ensure fairness and legal compliance.

Fairness and strategic considerations

Finally, in addition to the legal considerations, the question of fairness and strategy will be discussed. Some things may be legally permissible or impermissible – but regardless of this, founders and employees must also make sensible moral and long-term decisions.

When is employee participation fair? Fairness exists when opportunities and risks are distributed appropriately. An early employee bears part of the entrepreneurial risk by foregoing a secure salary; in return, he or she should share appropriately in the success if this occurs. “Appropriate” means: Does the equity roughly correspond to the value of the salary waiver (with risk premium)? Calculations can help here: If someone takes €30,000 p.a. less salary for 2 years, they are “investing” €60,000 in the company. In return, the expected equity value should at least be a multiple of this if the company is successful, otherwise the risk is not worth it. It is also fair to talk openly about the probabilities – founders should not promise unrealistic riches, but should make it clear that equity is a high-risk remuneration component. The employee, in turn, should understand that the founders themselves usually do/have done much more unpaid work and that their share is in proportion to this. Fairness also means that rules such as vesting apply equally to everyone – for example, it seems fair if founders are also subject to vesting (which often happens due to investor pressure), because then “everyone is in the same boat”. In addition, a fair investment should have transparent conditions: No hidden traps in the small print, but clear agreements on what should happen in different scenarios (exit, termination, insolvency).

One-sided risk shifting: It becomes critical when employee participation serves primarily to shift the entrepreneurial risk onto the employees without offering them realistic participation. Examples: A start-up promises a developer 1% of the shares, but pays him no salary for years – in the end the company fails, the developer has worked for nothing (while the founders may have been able to earn a living from investor money). Or an employee receives shares, but they are so tiny (e.g. 0.1% with 4 years of vesting) that there is hardly any motivation, but they still forgo some salary. Also problematic: if the shareholding is linked to hard lock-in clauses that effectively bind the employee without them being able to leave, even if the employment relationship develops badly – e.g. a non-compete clause without adequate compensation. Equity then becomes a golden cage. From the employees’ point of view, an equity stake is perceived as unfair if the risk/reward ratio is not right. One often hears the accusation that start-ups lure young enthusiasts with great visions only to make them work for a pittance – and only the founders and investors reap the rewards in the event of success. As a founder, you should avoid this scenario at all costs, as it destroys trust and motivation as soon as the discrepancy is recognized.

Moral aspects: In addition to financial fairness, appreciation also plays a role. An employee who is involved has a stake in the fate of the company. In return, they (rightly) expect not to be treated as an interchangeable resource, but as part of the close-knit team. Respectful cooperation, sharing of information and a culture of openness are morally required to ensure that work for equity is not a cynical exploitation of the workforce. Founders should not leave their team in the dark about where the company stands – otherwise it is easy to feel like you are working into the void.

Strategic considerations: For the company strategically, fair employee participation is usually beneficial: satisfied, motivated team members who feel like entrepreneurs will go the extra mile and not drop the pen at 5pm. The startup can thus build a culture that can make the difference in critical phases. Conversely, it is strategically fatal if employees see their participation as a sham – then the instrument loses any motivational effect and can turn negative (disappointment, cynicism, migration to established jobs). Founders must strategically plan who they offer how much participation and when. If you give too much too soon to someone who may soon leave the company, the equity is “burned”. If you give too little, you may not win the person over or they may feel undervalued. You also need to consider the issue of envy within the team: if only individual employees are involved, this can demotivate others. It is often advisable to have clear criteria as to who participates (e.g. all managers, or all employees above a certain length of service). Strategically, external communication is also important: a well-known comprehensive employee participation program can be a recruiting argument. However, start-ups should be careful not to overestimate what they are offering – in the end, factors such as team, technology and salary still count for many candidates. Equity is the icing on the cake.

Conclusion: Employee participation – work for equity – in early-stage start-ups is a complex but rewarding undertaking. It is only legally permissible to a certain extent and requires clean contracts that take labor and company law into account. If this arrangement is successful, both sides can benefit: The start-up gets committed fellow campaigners, and the employees get the chance to reap real entrepreneurial rewards. It is important to keep an eye on legal issues and moral aspects in equal measure. Just because something is legally possible (e.g. formally managing employees as partners without a salary) does not necessarily mean it is fair – and just because something is meant to be fair does not automatically make it legal (e.g. equity without a minimum wage). Successful implementation therefore requires a balancing act: opportunities and risks must be distributed in a balanced way, rights and obligations must be clearly regulated and everyone involved must be involved. Work for equity then turns from a risky balancing act into a genuine win-win model that turns colleagues into co-entrepreneurs and can carry a start-up through the difficult early phases – towards joint entrepreneurial success.