Principles: What’s the Difference?
Employee Shares
Employee shares are those acquired within the framework of an employment relationship. In this case, the employment relationship is the direct cause for the acquisition of these shares—employees receive them as part of their compensation or as a bonus. Companies frequently use Employee Stock Option Plans (ESOPs) to allow their staff to participate in the company's success. From a tax perspective, employee shares can be problematic because their profits are usually treated as income, which can result in a significant taxburden for employees, especially if the value of the shares has risen considerably over time.
Founder Shares
Founder shares, on the other hand, are typically acquired at the time of the company’s formation or shortly afterward. These shares are considered tax-neutral as long as they are not later reclassified as employee shares. A key difference is that, under specific conditions, profits from founder shares can remain tax-free, which can be a major financial advantage for founders. It’s importantto note that the classification as founder shares is tied to the shares themselves, not the individual. This means a person can hold both founder shares and employee shares, depending on when and under what circumstances they were acquired.
Significanceof the time of acquisition: Timing is everything
The timing of the share acquisition plays a crucial role in their tax treatment. Shares acquired directly at the time of the company’s formation retain their status as founder shares and therefore enjoy the associated tax advantages. This also applies to so-called "Dynamic Equity Splits," where founding shares are redistributed among the founding team over time. However, these agreements must be carefully structured and ideally pre-approved by the tax authorities to avoid a subsequent reclassification of the shares.
Aspecial Case: The Case of Late-Co-Founders
Things can get tricky when new team members join the company at a later stage, referred to as "Late-Co-Founders." In most cases, these individuals acquire employee shares, as they were not part of the original founding team. However, an exception can be made if the foundation and the later involvement of the person were pre-planned. In such cases, the shares can still qualify as founder shares, provided the agreement is well-documented and, ideally, pre-approved by the tax authorities. Without such documentation, there’s a risk that these shares could be reclassified as employee shares, resulting in significant tax consequences.
Conclusion: Early Planning is Key
The distinction between founder shares and employee shares may seem like a legal technicality, but it has significant financial and tax implications in practice. Founders should carefully consider the structure and distribution of shares early in the company’s lifecycle to avoid adverse tax consequences. Likewise, any future changes in the founding team or the addition of new teammembers should be carefully planned and documented to prevent unwanted reclassification of shares.
For Late-Co-Founders, thorough and forward-thinking planning is particularly crucial to minimize tax risks. It is worth seeking expert advice early on and making the necessary arrangements with the tax authorities to fully benefit from the tax advantages of founder shares.
