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Options, Vesting and the Slovenian Legal System

29/09/2016

Discouraged, due to poor management of the firm, a group of eight young semiconductor whiz-kids left their corporate job and started a company of their own. Being short on funds, they pitched their idea to some potential investors and eventually found one that offered them a proper funding in exchange for the right to buy the company, if it ever develops into a serious corporation.

1. Prologue to the revolution

The year was 1957, and little did anyone know that this first start-up venture and the lucrative exit of its founders will inspire so many others to follow, creating a new trend, the cradle of which became known as the Silicon Valley.

Today, this trend established itself as the mainstream, turning geeks into rock stars and some of the entrepreneurs into billionaires. One may very well argue that none of this could ever have happened without the employee stock options – a legal vehicle, allowing start-ups to attract, motivate, and retain the incredible talent, with a mere promise of future profit.

2. Introduction to Stock Options

In short, a stock option is a privilege, allowing the privileged person to call (purchase) or put (sell) the stock at the designated price, obtaining the difference in value between the set price of the stock and its contemporary market price.

Before start-ups made use of stock options more common, they were mostly awarded to the management of big corporations to help aligning their personal interests with those of owners, reducing the so called principal-agent conflict. Start-ups, however, being short on funds, started to use them for supplementing salary with a promise of participation in the company’s equity.

In fact, startups were so good at bringing the idea to the mainstream that in 2003, the EU commission established an expert group, to analyze the legal and administrative environment for Employee Stock options in the EU, hoping that this particular legal vehicle could: “help reach the goal of making Europe the most competitive and dynamic, knowledge-based economy in the world”.

3. Rest and Vest

Through time, the Silicon Valley startups developed more and more standardized employee stock option plans, leading to the famous "4 year vesting with a 1 year cliff" plan. To understand the plan, imagine that you are invited to become a back-end developer of an online platform that shall embody an idea with a potential to be worth millions. Let’s call it: “Amazen”. The founders would for example promise you an option to buy 1% share of the company for the price of one dollar, after the vesting period expires...

The 4 year vesting plan with a 1 year cliff basically means that if you were to leave the company in the first year, you get nothing. On the other hand, if you spend one year working for the company, you have successfully passed the cliff and obtained an option to become LLC member with 0,25% equity interest in the company. After that you become entitled to buy more and more equity each month, until at the end of the vesting period you obtain an option to place a call and buy the promised 1% share for a designated price of, for example, one euro.

In the meantime, you would have probably worked hard and wouldn’t contemplate leaving the company, in hope that after the vesting period expires; the 1% share is already worth millions.

4. Getting Geeky

An Employee Stock Option Plan provides a good way to attract employees – with a promise of great monetary returns, motivates them to perform better – in order to increase the company’s value and helps to retain them - since leaving the company would impair their ability to obtain the share. It is thus no wonder why such plans became very popular in the Silicon Valley.

Since "the sixties" the start-up fever has spread all over the world and the start-up ecosystem is developing rapidly also in Slovenia. However, the legal system, financial markets and economic reality are vastly different here. Implementing the Silicon Valley employee stock option plans in Slovenian start-ups on the “copy -paste” principle is therefore like trying to run a Windows app on Mac OS.

It’s not impossible, but it requires some additional work and it helps a lot, if your software engineer knows what needs to be done, or your computer is more than likely to crash.

5. The grass is always greener…

Of the top, it’s paramount to understand that most of the Silicon Valley startups are incorporated as Delaware C Corps. Best way to translate this into the terms, Slovenian Legal System is familiar with, is to say that they are loosely regulated public liability companies (d.d.), which are not listed on the stock exchange.

Slovenian start-ups on the other hand are incorporated as limited liability companies (d.o.o.). If we use a tech comparison again, one could say, these are different operating systems and the latter is significantly less user friendly, when it comes to the installation of the stock option program.

Furthermore, Slovenian startups rarely see several series of VC funding and are not constantly evaluated, so it is very difficult to determine, how valuable your share, and consequently your option really is.

On top off that, the capital market in Slovenia is rather illiquid, so even if you decided to incorporate as a public liability company and eventually go public, it would be anything but easy to sell the stock at a “fair price”.

6. Making it work

While it may seem like the chances of Slovenian startups making use of the employee stock option plans are looking rather grim at the moment, Slovenian legal systems provides for a number of alternative means for implementation of the employee compensation schemes besides stock options.

In fact, plenty of them are a lot more tax efficient, some of them are more flexible and a few are even easier to set up. It is important to begin with the end in mind, however, since each of them has some advantages and disadvantages that should be considered.

Once the goals and prospects of the company are clear, qualified startup lawyers can help to identify the best approach, mitigate the risks and provide potential workarounds and solutions when implementation is confronted by obstacles.

Authors

Picture of Luka Pregelj
Luka Pregelj