Why It’s So Hard for Startups to Create Wealth in Europe
Lawmakers across the Continent haven’t given startups the compensation
tools they need to share profits with employees. That’s changing.
October 1, 2019, 9:01 PM PDT
Johannes Reck should be feeling pretty groovy. He’s the co-founder of
one of the hottest startups in Berlin. GetYourGuide lets holiday makers
book tours online in 150 countries and is on course to increase ticket
sales this year by 75%. In May it raised $484 million from investors,
and it’s now valued at more than $1 billion.
Reck’s company is precisely the type of unicorn European policymakers
want to see more of as they champion entrepreneurship that can
kick-start much-needed economic growth. But he’s fuming. “It’s not even that I am disappointed—I am angry, really angry, because you don’t need
to reinvent the wheel here,” says Reck, a 34-year-old German with the
wiry build of a marathoner. “It’s not like we are asking politicians to
do something unheard of.”
Illustration: Jaya Nicely for Bloomnberg Markets
The problem? Reck can’t provide his people with a stake in the future of their venture without incurring crushing costs and hassle. For decades,
tech mavens in the U.S. have used stock options for employees to spur innovation—and unprecedented wealth. Unlike Silicon Valley, where equity incentive plans have become as ubiquitous as foosball tables and midday
yoga sessions, the options culture has yet to take root in many European countries. While some lawmakers are taking action to loosen restrictions
on pay, it’s going to be hard to close the gap when income inequality is becoming a more urgent issue on both sides of the Atlantic.
European consumers and lawmakers here have long decried outsize paydays
as unfair and vulgar. A few years ago the Dutch capped bonuses for
bankers, money managers, and other financial professionals at 20% of
their base salaries. Entrepreneurs must navigate onerous tax rates and restrictions that often make equity sharing and options more trouble
than they’re worth. When employees in Germany exercise options, they
have to pay income tax on the difference between the fair market value
and the strike price, and that rate runs from 14% to 47.5%. They also
have to pay a 25% capital-gains tax on additional profits when they sell
In contrast, American employees typically pay a 0% to 20% rate on
capital gains when options are redeemed, though they may have to pay
additional levies when they’re exercised, depending on the timing and
the type of equity incentive program. Germany and 14 other countries,
including Sweden and the Netherlands, are more burdensome than the U.S. regarding options, according to a 2018 study by Index Ventures, a
venture capital firm in London and Silicon Valley.
For entrepreneurs and venture capitalists, the problem isn’t just about attracting top talent. The compensation bind may also be a big reason
why Europe doesn’t produce world-beating tech companies at the same
level as the U.S.
Other forces are at work, too. Even though they’re part of the European Union, member states remain a fragmented collection of markets that
can’t muster the borderless scale achieved in America. Plus, there’s the widely shared belief that European business culture simply doesn’t
tolerate the experimentation and inevitable failures that are par for
the course in, say, Silicon Valley. While governments across the EU have devoted hundreds of millions of euros to venture capital-style programs
to invest in startups, the one tool entrepreneurs truly want remains out
“There are two ingredients to growth in a startup,” says Martin Mignot,
an Index Ventures partner. “One is capital, and the other is talent, and
when you’re not highly profitable you have to incentivize employees on
the promise of the upside. Your currency is that promise.”
Spotify, Klarna, and TransferWise lead a roster of European companies
that have shaken up industries with new products and created wealth for
their investors and employees. Likewise, a handful of countries hew to
the American approach on compensation; Britain, Italy, Portugal, and, interestingly enough, France, tax options as capital gains when they’re cashed in.
Yet they’re the exceptions. In many other European markets, startup
founders have to use various workarounds to vest employees in their
businesses. In Sweden, options can be taxed as income at rates of more
than 50%. Klarna, a digital payments powerhouse, sidesteps the bill by
issuing warrants priced at fair market value using the Black-Scholes
model, which are taxed as capital gains at 25% to 30% at the time of
sale. But, as incentives, fully priced warrants aren’t as potent as
cheaper priced options, says Knut Frangsmyr, Klarna’s chief operating officer. Companies in Austria, the Czech Republic, Germany, and Spain distribute “virtual share options,” but the instruments are really just cash bonuses by another name and may not deliver the windfalls that bona
fide options do when a company is acquired or holds an initial public
“We are so proud of our trade surplus and our automobile industry, but
we have fallen behind in the digital economy. This is where value and
growth will come from”
In Germany, at least, help may finally be on the way. Bettina
Stark-Watzinger, chairwoman of the Finance Committee in the Bundestag, Germany’s parliament, has crafted legislation that would cut the tax
rate on stock options in half by treating them as capital gains instead
of income. Stark-Watzinger, a member of the centrist opposition Free
Democratic Party, argues that Germany has become complacent about
supporting digital innovation.
She worries that promising tech companies will decamp to other countries
if lawmakers don’t change things. “We are so preoccupied with the
economy of the last century,” Stark-Watzinger says in her office suite
near Berlin’s iconic Brandenburg Gate. “We are so proud of our trade surplus and our automobile industry, but we have fallen behind in the
digital economy. This is where value and growth will come from in the future.”
VC-backed investment in European technology companies
It won’t be easy for Stark-Watzinger to persuade parties in Germany’s governing coalition to embrace legislation that might be seen as
favoring workers in the relatively well-off tech sector. Germany has
been far less comfortable than the U.S. and the U.K. about carving out exceptions in its tax system for specific sectors, even to stimulate innovation, says Michael Mandel, an economist at the Progressive Policy Institute in Washington who has studied the issue. It wasn’t until this
year that the German government proposed a tax break for research and development investments across industries, a common policy in many
Whenever the issue of tax credits has come up in the Bundestag,
lawmakers have tended to question whether lower revenue will undermine
support for social services—a political third rail in a nation that
provides free tuition at public universities and universal health care.
Mandel says that just because Washington is willing to bet that forgoing
tax revenue now will result in bigger inflows later, that doesn’t mean
Berlin should. “Germany has a very successful industrial system, so why should they break something that’s working?” he says. “And while German leaders would love to have more unicorns, they might want to develop
them their way, not the Silicon Valley way.”
Even so, there’s little doubt that stock options have fueled wealth and innovation in the U.S. Companies such as PayPal Holdings Inc., the
online payments pioneer, haven’t just made their founders wildly rich; members of the so-called PayPal mafia like Elon Musk, Peter Thiel, and
Reid Hoffman went on to start ventures that minted fortunes for
rank-and-file employees who can then start their own companies and begin
the cycle anew.
Index’s Mignot calls this the flywheel effect. The flywheel isn’t nonexistent in Europe: The 2018 IPO of Adyen, a Dutch digital payments processing company, made its top brass billionaires. Yet reforming
options rules across the EU would help make creating such flywheels the
norm instead of the exception, says Magnus Henrekson, the director of
the Research Institute of Industrial Economics in Stockholm. At the top
of the reform list is making sure beneficiaries aren’t hit with taxes
until gains are realized.
GetYourGuide’s Reck, for one, is relieved the issue is finally on the
agenda. In many respects, his company looks like a classic Valley
performer. It’s backed by SoftBank Vision Fund, and in September it
moved its headquarters into a renovated electrical substation that’s a
model of post-industrial hipness, with exposed red brick walls,
cast-iron beams, and fridges stocked with high-caffeine Club-Mate drinks.
Even though Reck was determined to add the pièce de
résistance—options—he gave up after realizing that the upfront tax bill would empty workers’ pocketbooks. So he implemented ersatz shares that
are essentially cash awards tied to GetYourGuide’s valuation.
Featured in the October / November 2019 issue of Bloomberg Markets.
Cover artwork: Victo Ngai for Bloomberg Markets
Those payouts are taxed as income, but only when they’re redeemed, and there’s no capital-gains tax. But GetYourGuide, which isn’t profitable
yet, must reserve cash to cover the outlays. “This has massive
disadvantages for the company,” says Reck. “We have a huge liability on
our balance sheet toward employees, which is obviously weird. And in an
IPO scenario, this is something that you have to explain to investors,
and that’s not great.”
Raisin, another startup, did bite the bullet, granting stock options to
its employees. Located in Prenzlauer Berg, a Berlin neighborhood of
funky cafes and old Soviet-style apartment buildings, Raisin runs an
online “deposit marketplace” that matches European savers with banks offering the best interest rates. Backed by Goldman Sachs Group Inc. and PayPal, it’s invested €16 billion ($17.7 billion) in assets.
Frank Freund, Raisin’s co-founder and chief financial officer, isn’t
wild about requirements that date to a bygone era. Whenever Raisin
grants shares, a notary must literally read the lengthy compensation
agreement aloud to both the employee and Freund at a hearing that can
take up to 90 minutes. Still, Freund believes the company made the right
call. “When you have participation in the company’s performance and
growth, it makes a big difference,” he says. “It would be great if significantly more companies would follow our example in Germany.”
Scott Chacon will take a pass on that. Chacon is an American
entrepreneur who co-founded the software development site GitHub Inc.
He’s been spending time in Berlin with his latest venture, an online language-tutoring service called Chatterbug Inc. Following a panel
discussion, he mingles with local techies over beers in a leafy
courtyard outside a VC firm.
Amid the bonhomie, he says Chatterbug chose to base itself in San
Francisco and Berlin to tap into the German capital’s diverse expatriate pool. It offered employees a choice of U.S.-style options or
German-style virtual shares. But ensuring the different programs were
equitable was impossible. Chatterbug now offers new employees restricted
stock units that aren’t pegged to a strike price (as options are) and
are taxed as income if they’re cashed in during a sale of the company.
Standing alongside Chacon, Anne Leuschner, the company’s COO, chimes in.
She says Chatterbug’s compensation fudge isn’t ideal, but it’ll do for now. “I wish we had the same system as the U.S.,” she says. “But they don’t want us to get rich in Germany.”
Robinson covers wealth in London. With Birgit Jennen