The Romanian IT sector is in full expansion, and the labor market offers companies insufficient resources for development plans. They seek employees whom they can retain long-term and who are motivated toward growing the company.
A particularly effective way to achieve this is by using employee remuneration instruments through granting stakes in the company’s capital (so-called “Employee Stock Ownership Plans”). In the following paragraphs we present such an instrument—granting virtual social shares as a form of employee incentive. We refer primarily to the most used company type in Romanian startups, the limited liability company (SRL).
Granting virtual social shares, equivalent to “virtual share plans” or “phantom share plans,” could become a tool used even by Romanian IT companies to incentivize key employees and retain them longer. In certain situations, the instrument may also be used to reward collaborators (for example freelance workers, Romanian or foreign, collaborating with a Romanian startup).
This incentive scheme gives beneficiaries the possibility to share in the financial success of the startup by placing them in a position similar to shareholders, without making them actual shareholders. Virtual shares will have a certain nominal value and will be considered to represent a percentage of the company’s entire share capital. Essentially, the mechanism makes virtual social shares merely a way of determining the cash bonus to which the beneficiary is entitled at a future moment.
Typically, the triggering event for the beneficiary’s right to the cash bonus is tied to a sale by shareholders (usually the majority) to an external investor. In case of such an exit, the beneficiary will receive a portion of the purchase price paid by the investor to the shareholders for their shares. The beneficiary’s monetary bonus will be set proportionally to the percentage of virtual social shares held—similar to if those shares had been part of the package purchased by the investor.
Of course, the parties may set that the beneficiaries’ right to monetary reward also be triggered by the distribution of dividends to shareholders. However, such a clause is more often used for external collaborators than for employees, since employees are remunerated via salary. In that case, beneficiaries will receive an amount directly proportional to what is distributed to shareholders as dividends, relative to the percentage of virtual shares held.
The specific clauses of the incentive scheme are established via a written agreement subject to approval by the general meeting of shareholders, and its implementation falls under the management of company leadership. The major difference between virtual social shares and real ones is that the beneficiary does not become a shareholder in the company—and thus does not have any rights or obligations deriving from being a shareholder. The beneficiary does not take part in general meetings of shareholders, has no voting rights on company decisions (including the sale of shares to external investors) and, unless expressly provided in the contract, does not obtain a shareholder’s right to information about financial statements or company operations. In conclusion, the beneficiary is treated similarly to a shareholder only in the case of specific events triggering cash payments, but holds no other shareholder rights.
From this stems the main advantage of awarding virtual social shares: it offers financial incentives to employees or collaborators only if the startup succeeds, while strategic decision-making power remains with the employer. Additionally, management remains simpler by maintaining a limited number of shareholders—an aspect also favored by investors. There are also tax advantages, but in favor of the beneficiaries. Since it creates only a future right to reward, the issue of taxation arises solely at the moment when the monetary amounts are paid.
Another typical issue in these agreements is the procedure and method of granting virtual shares. The interest of shareholders is to keep employees / key collaborators close as long as possible. Thus, as a rule, beneficiaries will not receive all the agreed virtual shares at the start; they will be granted gradually over a “vesting” period of 3–5 years. For example, a promise to grant virtual shares equivalent to 15% of the company’s capital may be split over 3 years, so that the beneficiary receives 5% of the virtual shares at the end of each year in which the employee remains with the company. In this way, shareholders ensure retention of the employee during the company’s growth period, and beneficiaries are motivated to stay to reach maximum benefit. Of course, parties may negotiate that beneficiaries lose or forfeit virtual shares already granted if they leave the company before the end of the vesting period. Similarly, shares already granted may be revoked if the beneficiary fails to fulfill certain conditions.
Additionally, the virtual share grant agreement may include the following types of specific clauses:
- limitations on the number/percentage of virtual shares issued;
- various limitations and scenarios in the event of capital increases by issuing new shares;
- eligibility of beneficiaries and their work, as well as prohibition of transfer of virtual shares given the company’s interest to incentivize certain key persons;
- granting certain information rights to beneficiaries;
- although the scheme by nature implies that beneficiaries do not become real shareholders, parties may deviate in the sense of converting beneficiaries into actual shareholders in certain triggering events, usually at the end of the vesting period;
- automatic grant of all virtual shares, even before the end of the vesting period, in the event of a takeover of the company or product by an external investor;
- setting the method of calculating the cash amount owed to beneficiaries at exit or upon dividend distribution to shareholders (deducting prior sale costs, outstanding company debts, handling taxes, etc.);
- the alternative that payment be made in kind, by granting shares / stakes in another company as a result of an external investment (merger by absorption / formation of another entity);
- insertion of a non-competition clause during the contractual period (until the event triggering payment) or after contract termination (in compliance with employment law and competition rules);
- granting additional guarantees in favor of beneficiaries by the company and/or shareholders.
Granting virtual social shares may become an incentive tool for key employees even in Romanian startups. Awarding them requires only a simple written agreement, which is very easy to use and implement.
Originally published on the Startup.ro platform.