ESOP vs VSOP for German Start-ups

ESOP vs VSOP: the short answer for German start-ups

The choice of ESOP vs VSOP is one of the first structural decisions a German start-up makes when it wants to reward employees with equity. An ESOP (employee stock option plan) gives employees real shares or options to acquire real shares in the company. A VSOP (virtual stock option plan) gives them a contractual claim to a cash payment on an exit, calculated as if they held shares.

For many years, German start-ups overwhelmingly chose VSOPs, because real shares in a GmbH are cumbersome to transfer and because employees could face tax on shares they could not sell ("dry income"). The Future Financing Act (Zukunftsfinanzierungsgesetz) expanded § 19a of the Income Tax Act (EStG) from 2024 and made real equity more attractive. Today, both models are viable, and the right choice depends on the company's size and age, its investors, the employees' expectations and the administrative effort the company can carry.

This briefing compares the two models, explains the tax rules including dry income and the deferral under § 19a EStG, and sets out drafting points in light of recent Federal Labour Court case law.

How each model works

In a real equity plan, employees acquire shares in the company, either directly or through a pooling vehicle, often at a reduced price or for free, or they receive options to acquire shares later. In a GmbH, every transfer of shares and every obligation to transfer requires notarial form (§ 15(3), (4) GmbHG), and new shares require a notarised capital increase. Employees become shareholders with voting and information rights, unless they hold through a pool that bundles these rights. In an AG, stock options can be serviced through conditional capital, which is more flexible.

In a virtual plan, employees receive a contractual promise: if an exit event occurs, such as a share sale or IPO, the company pays them an amount equal to the exit value per share multiplied by their vested virtual options, minus a strike price. No shares change hands, no notary is needed and the cap table remains clean. The employees are creditors, not shareholders, and the payment is a bonus for tax and social security purposes.

Dry income and § 19a EStG

The main tax problem with real equity is dry income: if an employee receives shares for free or below market value, the benefit is wages and taxable at the time of acquisition, although the employee cannot sell the shares to pay the tax. Two rules mitigate this. First, benefits from employee shares are tax-free up to EUR 2,000 a year if the offer is open at least to all employees with a current employment relationship of one year or more (§ 3 no. 39 EStG). Second, and more importantly, § 19a EStG allows taxation of the benefit to be deferred.

Under § 19a EStG, where an employer, or since the Future Financing Act also a shareholder of the employer, transfers shares in the employer's company to an employee free of charge or at a reduced price in addition to the salary owed anyway, the benefit is not taxed in the year of transfer. It becomes taxable only when the shares are sold or otherwise transferred, when 15 years have passed, or when the employment ends (§ 19a(4) EStG). Taxation on termination of employment can be avoided if the employer irrevocably declares that it will be liable for the wage tax when the shares are later sold (§ 19a(4a) EStG).

The deferral is limited to smaller and younger companies. The employer must not exceed, at the time of the transfer or in one of the six preceding years, twice the turnover and balance-sheet thresholds and four times the headcount threshold of the EU definition of small and medium-sized enterprises, and must have been founded no more than 20 years earlier (§ 19a(3) EStG). Applied to the current SME definition, this means up to 1,000 employees and either turnover of up to EUR 100 million or a balance sheet total of up to EUR 86 million. Group companies can be included under conditions.

VSOP taxation and labour law

Virtual options are taxed only on payment. The payment is employment income, subject to wage tax and, within the contribution ceilings, social security contributions. For employees, the tax burden on an exit is therefore higher than under a real equity plan where the gain is taxed as capital income. Payments for several years' work may qualify for reduced taxation of extraordinary income. For the company, the payment is a deductible business expense, and the obligation must be recognised in the accounts once an exit becomes probable.

Because VSOPs are part of the employment relationship, labour law applies. Plans are usually standard terms and therefore subject to the fairness review in §§ 305 ff. BGB. The Federal Labour Court has held that a clause providing that vested virtual options are forfeited immediately when the employee resigns unreasonably disadvantages the employee and is invalid, and that the same applies to a clause under which vested options lapse after departure twice as fast as they vested (BAG, judgment of 19 March 2025 – 10 AZR 67/24). The court treated vested options as consideration for work already performed. Many VSOPs drafted before the decision contain similar forfeiture clauses and should be reviewed.

ESOP vs VSOP at exit: a worked comparison

Illustration: a hypothetical German GmbH grants an early employee either 1,000 real shares through a pooling vehicle under § 19a EStG or 1,000 virtual options with a strike price equal to the nominal value. Five years later, the company is sold at a price that values each share far above its value at the time of grant.

• Under the real equity plan, the employee pays no tax at grant. On the sale, the benefit deferred under § 19a EStG becomes taxable as wages, limited to the value at the time of grant, and the increase in value since then is taxed as a capital gain at the flat rate for private investors, plus solidarity surcharge and church tax where applicable. The employee also shares in the sale price directly as a seller and may have to give limited guarantees.
• Under the virtual plan, the company pays a cash bonus equal to the exit value per share minus the strike price for each vested option. The whole amount is employment income taxed at the employee's progressive rate, with social security contributions up to the ceilings. The company deducts the payment, but needs liquidity at closing; in practice, the buyer or the sellers fund it out of the purchase price.

In this scenario, the employee's net proceeds are usually higher under the real equity plan, while the company's administrative effort is higher. The comparison between ESOP vs VSOP shifts if the company does not meet the § 19a EStG thresholds, if the employee leaves before the exit without an employer declaration under § 19a(4a) EStG, or if the exit value is low and the liquidation preferences of investors absorb most of the proceeds.

Choosing ESOP vs VSOP in practice

For an early-stage GmbH with a small team, a VSOP remains attractive because it is quick, cheap and keeps the cap table simple. As the company matures, many founders consider a real equity plan, at least for key employees, because employees increasingly ask for capital-gains treatment and because § 19a EStG removes the dry income problem in many cases. A pooled structure, in which employees hold their shares through a GmbH & Co. KG or a trust arrangement, reduces notarial effort and keeps voting rights manageable.

Investors' views also matter. Venture capital term sheets typically specify the size of the employee pool and whether it is pre-money or post-money. Investors often accept either model, but they want clear leaver terms, limits on dilution and a mechanism that works smoothly in a sale. The choice of ESOP vs VSOP should therefore be made together with the financing round, not afterwards. See our page on venture capital and start-ups.

Hybrid models are possible: real shares for senior staff under § 19a EStG, virtual options for the wider team. The administration of two plans has a cost, but it lets the company tailor incentives to different groups.

Drafting points for both models

• Vesting: typically four years with a one-year cliff. Define clearly when options vest and what happens to vested options on departure, in light of the BAG decision.
• Leaver rules: distinguish good and bad leavers; for real shares, include call options for the company or investors at defined prices, which require notarial form for GmbH shares.
• Exit definition: share deal, asset deal, IPO, and treatment of partial exits and secondary sales.
• Dilution and anti-dilution: how financing rounds affect virtual options; whether the strike price adjusts.
• Waterfall: how liquidation preferences of investors affect the payout to employees.
• Tax and withholding: who bears wage tax and social security; the employer's § 19a(4a) declaration.
• Data and transparency: information rights for employees on valuation and cap table, balanced with confidentiality.
• Governing documents: consistency between the plan, the articles, the shareholders' agreement and the investors' consent rights over new grants.

Founders and senior managers in private-equity-backed companies face a different set of issues, covered in our briefing on management incentive plans.

How TRW & Co helps

We advise German start-ups, founders and investors on ESOP vs VSOP decisions: drafting virtual option plans and real equity plans, pooling structures, § 19a EStG eligibility and employer declarations with tax advisers, leaver and vesting terms that reflect current case law, and the integration of employee pools into financing rounds and exits. We also review existing plans after the BAG decision. Contact us to discuss your employee participation plan.