GERMANY Law and Practice Contributed by: Carsten Berrar, Florian Späth and Heiko Blaut, Sullivan & Cromwell LLP
of employer or reaching of a minimum holding period of 15 years will no longer necessarily result in the termination of the tax deferral. As a result, tax is only due at the time when the com - pany shares are actually sold by the employee, thereby avoiding the dry income problem. Since the amendment was introduced, shareholdings in any affiliate of the employer company (within the meaning of Section 18 AktG) are also subject to this benefit, which is of particular interest for foreign start-ups with subsidiaries in Germany. To sum up, with the Future Financing and the Fund Location Act, the legislator successfully attempted to offset the competitive disadvan - tage that Germany faced compared to other jurisdictions such as the US. However, certain issues persist. For example, the provision (still) excludes later-stage companies despite its broadened eligibility criteria. Finally, social secu - rity contributions incurred at the time of acquisi - tion are not deferred and fall due within the dry income window. 5.4 Implementation From a process perspective, investment terms are typically outlined in non-binding term sheets, following an assessment of the market, team and an initial validation of the business model by investment teams. As due diligence progresses and binding documentation are entered into, investors in a round often sign and close their investments concurrently, contingent upon fulfill - ing conditions precedent. The “option pool” or VSOP – whether newly established or expanded upon (ie, the creation of additional awards within an existing pool or scheme) – would ordinarily take effect at the time of a financing round’s closing or, in particular, if additional structuring work is required, may be implemented thereafter.
New investors generally expect growth compa - nies in which they invest to increase or “refresh” the size of their employee equity incentive pool at the time of their investment. This becomes a key topic of negotiation because it is ultimately a commercial question with direct bearing on the company’s valuation. As part of the key invest - ment terms, existing shareholders and new investors will be required to find alignment on who bears the dilutive effects of an increase of the incentive pool or the (additional) number of instruments to be awarded. The point has been labelled “option pool shuffle” and concerns the questions as to whether the prospective dilu - tion will be borne by existing shareholders only (and run against the pre-money valuation on a fully-diluted basis) or by all – ie, existing and new investors alike (in which case the increase in instruments runs against the fully-diluted post- money capitalisation). When it comes to valuation and dilution, investors participating in a round will seek to have visibility regarding the amount of euros they are investing and what their investment amount translates into in terms of their fully diluted pro rata ownership in the foreseeable future. If the increased incen - tive pool were to be factored into the post-mon - ey valuations and all investors equally shared the dilutive effect, new investors would immediately be diluted after closing, and the relative stake purchased would require adjustment. Therefore, ESOP and similar increases are mostly counted against the pre-money capitalisation and are non-dilutive in respect of newly issued shares. Discussions typically evolve around the sub - stantiation of hiring and retention needs during a predefined timeline that the founding team will be incentivised to demonstrate in order to limit the size and, consequently, the dilutive effect of a pool increase and the new investors’ argument
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