Two giant European VCs want founders to give more equity to employees

European VCs are getting tired, and who can blame them. Europe’s startup industry has boomed in the last ten years, and no-one can say it isn’t a world away from what it was in previous decades. However, European founders are consistently getting it wrong in how they allocate options and equity to staff. This is have a few major effects. It’s stopping startups from attractin the talent they need out of bog corprpates and the tech giants. It’s also constraining how the wealth is shared around on exit, and thus how many people go on to become entrepreneurs themselves.

Everyone (by now at least) should be aware of the PayPal Mafia (Elon Musk anyone?) or the Skype Mafia. But why are there not more ‘mafia’s’ being created in Europe, and faster? European VCs won’t say it out loud, but they are fed up. Tired of startups where only one or two people (the founders) become millionaires, slow the scaling of the company, hold it back from attracting teltnt and tired of Europe not creating more entrepreneurs from these early employees.

It’s time to change that culture, and today two major European VCs have mounted an assault on the issue.

The first is Index ventures.

Realising that Founders were relying on old posts by US VCs like Fred Wilson or perhaps Seedcamp to work out how much in share options they should allocate to employees, Index has gone ahead and done a huge amount of research into the area.

If we want to produce the next wave of global tech giants then giving employees ‘a greater stake in the game’ is Index’s view. In their new report, “Rewarding Talent” they’ve found there is an uneven playing field holding European founders back.

But the real kicker to the report is that Index is also launching OptionPlan, an online web app for entrepreneurs to design their own stock option plans. This is not live yet. It will be released on Thursday, 30 November 2017. I’ve seen the app ahead of launch, and it might just be the most useful tool for founders I’ve seen in a long time!

Martin Mignot, partner at Index Ventures says, “Access to talent is the single most important ingredient for creating transformative tech companies, which is why we are calling on European governments to help level the playing field for our ambitious entrepreneurs by creating the right conditions to support and incentivise employee ownership. Attracting the best talent is the biggest focus for all entrepreneurs and should be the singular focus of all governments who seek to support innovation, entrepreneurialism and job growth.”

Why should they do this? Well, the competition from big companies is just too strong now.
Index Ventures founding partner Neil Rimer says: “Europe is on the cusp of greatness, but risks coming short of building companies the size of Amazon, Facebook and Google if it cannot compete for the talent it needs.”

The report’s underlying research is extensive. It has analysis of over 4,000 individual option grants from more than 200 startups across Europe and the US; cap table analysis by funding round across 73 companies in the Index European portfolio; a Survey of ESOP practices completed by executives from 53 European startups and former startups, representing over 11,000 employees; in-depth interviews with founders, CFOs and executives of 27 Index-backed European companies from seed stage to post-IPO; and a review of regulatory and tax policy in the US and other key European markets, supported by Taylor Wessing and Wilson Sonsini.

The report found that:

  • On average, employees own 20% of late-stage start-ups in the US, versus 10% in Europe.
  • Employee equity is less consistently on offer to employees in Europe, with two thirds reserved for executive level employees in contrast to the US where the reverse is true.

  • There is also disparity in Europe when it comes to how deeply technical the business is, with those in AI or enterprise software significantly more likely to receive such benefits than those in e-commerce, for example.

In other words, European employees are not being encouraged by the low options they are receiving, European founders are not offering is as much as their US counterparts, and less technical employees not being treated as equally, hampering the growth of the eco-system.

Index says there are three main factors preventing greater adoption of employee ownership as a means to secure talent in Europe. Firstly, governments must create the right conditions to encourage broader employee ownership.

Index found that European employees are often being penalised for their stock options in the startup they work at. In much of Europe, employees must pay a high strike price and are heavily taxed on exercise as well as sale, with leavers often receiving nothing. The US is totally different and stock options are supported and encouraged by more favourable tax policies.

National tax policies across Europe are also working against giving employees options. Index Ventures’ cross market analysis shows that the UK tops the rankings for creating the best conditions in Europe for start-ups, scoring higher even than the US. France and Ireland also show well. However, in Germany and Spain the figures are much worse, and these countries will need to work on this area if they are to encourage the development of startups.

The financial benefits of employee ownership are also being lost in the conversation. Index found that European workers still do not expect stock options much of the time. Lastly, Index found that European entrepreneurs have to date suffered from a lack of information on the level of ownership incentives offered by their counterparts in Europe and the US.

Mignot also told me their research found that the EMI options scheme is more forward thinking in the UK than the US. “If ever a European country emulated the UK’s scheme then whole of Europe would be world class and would trigger talent moving from traditional corporates to startups,” he said

“There are a crop of companies coming through who will be big, like Deliveroo, but in order to get the next generation, of startups, what’s holding us back is our ability to attract and retain talent. Looking long term, staff with options will spread through the ecosystem. Criteo made 50+ millionaires, and all are now funding other startups or starting them. This is critical.”

Secondly, today Balderton Capital has released its own report on Employee Equity which outlines why startups should give equity to employees; how equity compensation works and why it should be used; how to engineer a fair and efficient plan; and how to navigate the many complex issues that implementation in different European companies.

This huge 59 page long deck has practical spreadsheets that address many dimensions of such a program such as how to evaluate and present the value of a given stock grant; how to model the vesting of a grant; how to establish a grant refresh program; and how to present the equity program and gain approvals from the company board of directors.

As you can tell, investors are worried about this. They are worried that corporates and huge tech giants like Google and Facebook will use huge salaries to lure the talent away from startups where they might get equity. But for startups to work, that equity has to be attractive. Founders need to understand how to allocate it well, and governments need to start legislating to encourage it if European startups are to flourish.

If things go well, then Europe will get the same flywheel effect you see in Silicon Valley. You get more advocates for the tech ecosystem, then you can optimise for long-term value and encourage policy makers to incentivise startups.

Plus, of course it also means you can encourage a corporate employee to find out how much they might get on the upside by joining a startup…

Published at Mon, 27 Nov 2017 14:42:57 +0000