Germany approves financial reforms to help its tech industry compete with Silicon Valley

The reforms, which have been in the works for sometime, had been widely expected.

Some of the major changes will be to employee stock ownership plans, which allow companies to hand a slice of the business to their employees. 

Martin Mignot, a partner at Index Ventures who has pushed for reform to stock options policies in Europe to improve tech employee retention, said that previously the laws were "disadvantageous for employees and a really unfair policy for everyone."

"There was a formal ESOP plan in law in Germany but it was just so cumbersome administratively where every minority shareholder gets a vote and veto right almost, and also very little tax advantage," Mignot said, referring to the acronym for employee stock ownership plan.

"It made it such that it was virtually impossible for companies to use actual ESOP," he added.

Index has invested in a number of high-profile German tech startups, including human resources software firm Personio and financial service startup Raisin.

Under the new German rules on ESOPs, taxes on employees' stock options will be deferred until the point of sale so that staff aren't faced with the prospect of being taxed on their shares as soon as they receive them, according to a draft version of the legislation viewed by CNBC.

Meanwhile, the scope of the plan will also be widened so that more growth companies can benefit.

The threshold for companies that can take advantage of German ESOP plans will be raised so that firms with up to 1,000 employees and a maximum of 100 million euros ($108.7 million) of annual revenue can distribute shares to staff. 

Capital gains tax rules will also be changed so that startup employees are charged tax on the profits they make when they sell their shares. This tax is viewed as a reflection of the risk that employees take on a young, unproven startup.

The new legislation will also mean that companies listing in Germany can issue dual-class shares. Those shares are a key point of attraction for venture-backed startups, as it allows founders to maintain control over the business.

Europe now has a much more established venture capital industry, which has provided startups with access to ample amounts of cash, with billions of dollars worth of funds having been raised by firms across the Continent.

But bottlenecks remain around attracting talent that mean it has been harder to compete with Silicon Valley giants when it comes to finding the best people.

European tech startups are unable to match some of the offers by U.S. giants like Google, Amazon, Meta and Microsoft — but stock options provide them with an alternative way to compete on compensation, Index Ventures' Mignot said.

Of particular note, proponents of the reforms in Germany say they want to tackle a "brain drain" where talented local tech workers are leaving for the U.S.

"We shouldn't think about startups as small companies, we should think about startups as the new industry leaders for tomorrow — one of our investors often says, 'Who in 10, 20 years will be one of the leaders of the S&P 500 in 20 years?'" said Hanno Renner, co-founder and CEO of Personio.

"This regulation is a big step to accelerating the entire flywheel in Germany and make sure German startups have the ability to attract the best talent, so when they come to a startup like Personio, keep growing and keep building global champions," Renner said.

Tao Tao, co-founder and chief operating officer of German travel startup GetYourGuide, said that German firms would struggle to match the same pay packages on offer from the likes of Google, Meta or BMW.

"The industry wants to be competitive on the global stage," said Tao, who has moved to New York to grow GetYourGuide's footprint. "I think this is really leveling the playing field. We need to make it much more attractive and not less hard to attract great talent to Europe and to Germany."

The plans have been in the works for some time. Germany introduced rules to make its employee stock ownership plans more attractive back in 2020. However, startups and investors, including venture capital firm Index Ventures, said the rules didn't do enough to address their concerns.

Now, the firm says that Germany will be among the leading countries in Europe when it comes to ESOPs.

More remains to be done, tech entrepreneurs and investors told CNBC. In Germany, companies with a group structure still won't apply for ESOP rules, according to one German startup founder, who preferred to remain anonymous discussing sensitive matters.

Going forward, Mignot hopes that the European Commission, the EU's executive arm, will approve a pan-European framework for stock options that would allow tech companies to "passport" stock options into different countries like France and Italy.

"Though there are still individual country plans, they are not the same," he said. "You have similar qualities [but] you can't issue one stock option in one country that is applicable everywhere and could be the same system everywhere."

He added, "This idea of a phase two in an ideal world where there would be some form of stock option passport, where any country could issue a stock option that would be recognized by any European country so you only do it once. … It would allow you very easily to scale across countries."

Meantime, separate plans are currently being devised by the government that would allow pension funds to invest directly in venture capital funds in Germany.

Tech industry insiders in the country have expressed frustration that there is more ownership of companies from big North American pension funds in German tech companies than there is from domestic pension funds.

This, they argue, means that German taxpayers wouldn't reap the benefits if a company successfully goes public or gets acquired at a higher valuation.

Correction: Some of the major changes will be to employee stock ownership plans. An earlier version misstated the type of plan.