Employee shareholdings - differentiation from founder shareholdings

Case 1: New foundation of a start-up company

1. facts of the case

A and B are old school friends. Together with C they studied at the ETH. After graduating, A and C did their doctorates. B took up employment as an employee at a technology group. Over the years they kept in touch and work on ways to implement their plans from their student days. At ETH they attend a workshop on "Start-up, from the idea to founding a company". They believe in the potential of their plans and want to realise them.

A, B and C found xTech AG with registered office in Zurich on 1 July 2016 with a share capital of 100,000 shares of CHF 1 each. They each subscribe to 1/3 of the shares.

A and C are managing directors of xTech AG and receive a small salary. B remains employed by his employer for the time being and supports the others mainly with his technical know-how and contacts.

xTech AG needs further funds. On 10 December 2016, A, B and C as well as friends and family subscribe for more shares. They pay CHF 2 per share (par value CHF 1, premium CHF 1 per share). The net asset value as of 31 December 2016 is CHF 1.05 per share.

On 1 January 2017, each founder sells 1,500 shares each to the first hour employees D and E at CHF 1.50 per share to thank them for their commitment and to let them share in the hoped-for success of xTech AG.

In November 2017, the start-up succeeds in convincing two business angels. The share capital is increased by 100,000 preference shares with liquidation preference, the nominal value is CHF 0.10, and CHF 7 per share is contributed.

In May 2019, a financial investor joins the company. The share capital will be increased by a further 100,000 preference shares with a nominal value of CHF 0.10 each. The amount per share is CHF 40.

C sees his professional future elsewhere and wants to leave. Another investor acquires his shares at CHF 60 as of December 2019.

In January 2020, the newly hired executive F acquires shares in A and B at a price of CHF 30 per share. F does not agree with various personnel decisions and leaves the company at the end of the year. He is contractually obliged to return his shares to the AG at the acquisition cost.

Investors are pushing for an IPO. The IPO takes place in April 2021 and is a success.

Questions

1. Are the shares of directors A and C employee shares? How are B's shares to be qualified?
2. What are the tax consequences of incorporation at shareholder level?
3. Capital increase by the founders: Are these employee or founder shares?
4. What are the tax consequences of a capital increase by "Friends and Family" for the shareholders?
5. What are the tax consequences of the acquisition of the shares by employees D and E?
6. What are the consequences at the level of the existing shareholders of the capital increase within the scope of the seed funding?
7. The sale of the shares by C has what tax consequences for C and the remaining founders and other shareholders?
8. What are the tax consequences of the entry and exit of F
9. What are the tax consequences of the IPO for the founders and the employees involved?

Case 2: Foundation with obstacles

1. facts of the case

B's employer - the Y Technology Group AG - wants to found xTech AG together with A and C. B, as a representative of Y Technology, is to become a member of the board of directors. B, as a representative of Y Technology, is to become a member of the board of directors.

For reasons of corporate policy, it was decided only a few days before the founding that the group would not act as a founder, but might participate at a later date.

As a result, there is a rift and B terminates his employment. Y Technology Group AG insists on the contractually agreed non-competition clause.

It is not possible for B to subscribe to shares in xTech AG as part of the formation. Only after two years have passed does he join the management of xTech AG and acquire 16.6% shares each from A and C at nominal value.

Questions

1. B considers himself a founding shareholder. Do you share this opinion? What are the possible tax consequences?
2. What if B had been allowed to subscribe for shares at the time of incorporation, but he wanted to go on a world tour for a year first and then participate?
3. What if it is clear that B contributed to the ideas/business plans prior to incorporation, but may not receive the shares until after the end of his 6-month notice period?

Case 3: Investment convertible loan

1. facts of the case

xTech AG is a promising start-up company founded by three ETH graduates. The company is dependent on investors for the further development of the technology and the market launch.

Z recognises the potential of xTech AG and wants to invest privately in the start-up. She has enough of her own free funds to finance CHF 500,000. xTech AG urgently needs the liquidity. An agreement is reached on a convertible loan, as this generally incurs fewer costs and delays than a capital increase.

The term of the convertible loan is three years. The convertible loan is issued at par and repaid at par and bears interest at 3%. At maturity, the voluntary conversion takes place at market value (variant: with discount or conversion premium of 12% on the market value), whereby new shares (conditional capital increase) are used for this purpose.

Variation 1: Z joins the management of xTech AG during the term, this had already been agreed at the same time as the convertible loan.

Questions

1. What are the tax consequences for Z during the term, at redemption and at conversion?
2. What risk does Z run if she becomes part of the management? Do the shares qualify as founder shares if Z grants the convertible loan shortly after incorporation?

Case 4: Dynamic Equity Split

1. facts of the case

A, B and C want to found xTech AG. A will mainly be involved in an advisory capacity. B works part-time at another company and will divide his time between the start-up and permanent employment. C will work 100% for the start-up and actively contribute to the development of their technology.

The founders' financial resources are limited during the start-up phase. They ask themselves whether their work should be remunerated exclusively by means of wages, or whether a dynamic equity split might be more expedient.

They agree that their initially subscribed participation quotas (1/3 each) can be adjusted among themselves during 24 months (variant: 12 months) to reflect the individual value creation of each founder.

Questions

1. What tax pitfalls do you see?
2. Which regulations do you recommend?

Case 5: Business start-up / consultant

1. facts of the case

A, B and C found xTech AG in 2017. After two years (2019) they realise that their original idea, the synthetic production of wheat, does not work. B drops out of xTech AG and transfers his shares at par to A and C, who also transfer the shares to D at par. Together with D they want to go into software development and change the purpose of xTech AG accordingly.

After another year (2020), they are able to win Dr. E, based in Germany, as an advisor (alternative: member of the board of directors), who contributes to the positive development of xTech AG due to her network and expertise in the software sector. As a sign of her trust in xTech AG, she acquires 1,000 shares each from A, B and D at the proportional net asset value (= current wealth tax value) of xTech AG as of 1 March 2020.

After various capital increases and successful business development, D sells his shares to a financial investor after three years (2022). Dr. E keeps her shares for six years (2026) and then also sells them to the financial investor.

Questions

1. Does D make a tax-free capital gain? Does he qualify as a founder?
2. What are the tax consequences for Dr E on acquisition and on sale?
3. Does it make a difference for tax purposes whether she works as an independent consultant or as a member of the board of directors of xTech AG?
4. How is a relevant formula value to be determined in view of the capital increases in the meantime?