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You can hardly go a day without seeing an article heralding the prodigal rise of Berlin’s startup scene. It is true that Berlin has tremendous momentum and potential. There is an iconoclastic streak to the city, and it is attracting young makers with creative ambitions from all over the world. But there is something at the core of Berlin’s startups that is limiting their potential. German corporate structure and inefficient tax treatment is restricting young Berlin startups’ ability to effectively incentivize talent.

Growing tech companies need to source talent globally, and it’s an incredibly competitive market for high performers. People of this calibre, particularly those who have worked in the US or the UK, are used to being offered options as part of their compensation package. However, in Germany standard employee share option plans often don’t exist. Startups often implement VSOP (virtual share option programs) instead of standard option plans because the administrative overhead and employee tax liabilities associated with traditional option plans are very high.

Potential competitive hires perceive VSOPs to be overly complex, less tangible, and fraught with risks that don’t occur with standard options. Obligations to employees in a VSOP are often structured as an employee benefit or cash liability, putting them lower in the capital structure than common shareholders. And employees who leave the company often have to forfeit their virtual share options.

Several founders of Berlin-based startups have told me they have lost potential hires due to the disadvantage of virtual share options. If a hire has one offer for real options and another for virtual ones, which do you think she is more likely to choose?

If VSOPs are so disadvantageous, why implement them? The truth is, Berlin’s startup founders don’t really have viable alternatives. There is no tax-advantaged employee option scheme in Germany. Employees first have to pay to exercise their options, then the difference between their strike price and the market price of their shares is taxed at their income tax rate. Finally, when they sell their shares they are taxed a further 28 percent. Real option plans come with other burdens. Companies often have to create an entirely new share class, and minority shareholders must be consulted on major corporate decisions.

Berlin startups are losing in the battle for competitive talent due to the lack of a tax-advantaged employee option scheme. Elsewhere in Europe policymakers are more supportive and offer schemes that don’t penalize the use of share options to incentivize teams. In France, startups can use the BSPCE (Bons de Souscription de Parts de Creatur d’Enterprise), and in the UK, the EMI (Enterprise Management Incentive) scheme offers the friendliest employee option tax treatment on either side of the Atlantic.

Due to all of the above, founders and investors creating and investing in Berlin-based companies often choose to domicile their companies elsewhere, like the UK or the US, despite the fact that the company may be based and headquartered in Berlin. It’s high time German policymakers recognized the tremendous potential of their startup ecosystem and gave the iconoclasts the tools to build world-class teams that will help shape tomorrow’s world.

Colin Hanna is Principal at Balderton Capital.

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