3 resolutions to kick-start 2019 in Berlin:
Looking back at 2018, one of my most popular articles on Medium was my prediction piece titled Berlin’s Got Talent: 5 Startups to Watch in 2018. Indeed all my top picks had continued success throughout the year. For example, the mobile bank N26 did further prepare to enter the UK and U.S. markets as outlooked — and the bank says it finished 2018 with a total of over two million customers. Another startup on my list, Replex, was named by Forbes as one of the 100 most innovative German startups for 2018 last month.
So looking forward to 2019, here are some potential new years resolutions Berlin’s startup scene could consider for increasing the ecosystem’s success over the next year.
1. Be inspired, don’t just copy:
This isn’t a new piece of constructive criticism. Berlin appears to be fond of copying. It can be pretty shameless. Some startups make no attempt to evolve beyond something that already exists. Sure, in business it’s good to benchmark your competition. But what seems to go on in a few places around Berlin isn’t benchmarking, it is straight copying.
I find this sad for a few reasons. Startup employees with genuine creativity who care about providing value to customers and shareholders feel like their internal flame is being slowly extinguished at a clone factory.
It’s also not a good way to mentor young people just entering employment by teaching them that they shouldn’t think for themselves but instead switch-off their robust brains and just copy. What will these workers be like in 10-20 years time when they’ll most likely be needed to use their creative problem solving brains? And demonstrate true leadership skills? This just feels damaging for long-term career development. What happens when Germany’s workforce has a fat layer of mid and senior level managers who are only skilled at copying?
On the other hand, buyers — including German consumers — deserve better than cheap knock-offs being pushed to try and position a startup for a quick high priced acquisition for founder paydays and investor profits.
Copying will only make you as good as the one you’re copying *IF* you’re lucky. It will never make you better. And in today’s highly competitive marketplace creating a unique brand buyers fall in love with is necessary for long term success.
I also wonder how Berlin will manage to outmanouver the largest startup hub in Europe, London, if it’s main startup driver happens to be cloned companies? London’s having a bit of a moment with Brexit, but people don’t actively sit around thinking about existing businesses they can copy and roll-out for fast money. But this absolutely happens in Berlin. All. The. Time.
Further, here’s a U.S.example. Think about Facebook. It was not the first social network. MySpace and LinkedIn were already operational. However, Mark Zuckerberg didn’t sit around in his dorm at Harvard wondering how to clone MySpace. Instead he was inspired by the other nextworks and created something new with clear differentiating factors that people could really fall in love with. Since Facebook was different enough to become original — people did fall in love with it — and Facebook was able to scale globally.
Copying what everyone else is doing also isn’t a long-term strategy for growing a sustainable economy. If all you want to do is create clones and sell into foreign companies as fast as possible — that’s not really setting the German economy up to have decades of rich global businesses driving it.
Germany is still lucky to have a strong automotive industry but, with the way startups in Berlin are now, I’d worry about relying on the city’s copy-cat segement of startups to be the next generation of long-term German giants. Consumers fall in love with things that are original AND original can be scaled globally. Either be completely original or be inspired. Don’t just copy.
2. Stop competing on price:
This is an outdated and, in my opinion, unhelpful strategy that has roots in the City’s own marketing. Perhaps competing on price worked 15 years ago to get people back into Berlin. These days not only is it not exactly true, it sets the bar very low for the expectations of companies and founders coming to Berlin.
Many who are enticed to come to Berlin by this marketing campaign, expect to pay the lowest price for everything including the people they hire. So, employees are faced with a rude reality when they’re offered salaries that are below the market rate. Further, if you stroll into any online expat forum, you’ll see there are always workers talking about how some jobs didn’t even pay at all.
For the unlucky, they were greeted by the unofficial ‘Berlin Startup Welcome Package’ where they got hired, and then gave a big old brain-dump of intel into their new employer during the onboarding process only to be let-go just before actually reporting for their first shift. Sometimes the startup worker is cut even after having paid for their own relocation.
Out of the startup employees who have paid for their own move and experience fast job loss, there’s a segement further that still never receives any conpensation for the work completed and costs incurred. Other times people struggle to get their last paycheck paid. Indeed, the word I see used most online to describe Berlin’s startup employment offering is ‘precarious’.
While these shenanigans may be happening in other startup ecosystems, they simply aren’t talked about or documented at the rate that I see this happening in Berlin. Cruise into the expat forums and read for yourself. People with first-hand knowledge of the Berlin scene, regularly try to be a pal and drive newcomers to other cities in Germany where employment is more dependable.
This reputation for Berlin as having ‘precarious employment’ is not good and can only be cleaned-up by following proper human resources policies and laws. For startups to be encouraged to stop exploiting talent, the City itself needs to care and actually enforce rules and regulations on the employers who are violating the norms.
For that to happen, Berlin needs to stop marketing itself as the cheapest option going because people tend to not respect things when they’re operating on a race to the bottom. And Berlin isn’t cheap anymore — something that’s sparked several protests recently.
For those that haven’t heard, housing is in short supply across Germany’s major cities meanwhile prices are at an all-time high. Many expats complain about the ruthlessness of house hunting. Their stories contain the same shenanigans from Berlin to Munich.
“Expat forums are filled with tips, and an English-speaker advised newcomers to submit CVs, pay slips, credit histories and references to potential landlords. Apartment hunters often wind up starting jobs while they urgently hunt for a home in the evenings. They sleep on friends’ couches, mull bribes and swap stories of scams.”
It’s common knowledge that having people living in your city is a good thing. Workers spend their wages locally on things like rent, food, transportation, and entertainment. But it isn’t good enough to just take money from people without providing a lawful environment for them to live and work anymore. All business schools teach the dangers of competing on cost. Berlin is not an undesirable city trying to regenerate. It is a nation’s capital and the second largest city in Europe. And the business policy makers need to start behaving like that.
3. Make business regulations more competitive:
After updating the city’s strategy to not attract business by competing as the cheapest option going, leaders need to improve business regulations to make things more accessible and inclusive.
Now let’s take a step back to understand where things are today. Berlin entered the 20th century as a global powerhouse for technology and banking. For example, Siemens built and operated the first telegraph from Europe to the United States from Berlin. At the same time that Berlin was creating world changing technological innovations, the city was also home to many international banks. But then the World Wars happened and brought very dark times. Afterwards Berlin was left destroyed, de-industrialized, and divided.
As a result, all the big companies and banks moved away, and new companies avoided the very complicated situation Berlin had. Even when reunification happened in 1990, Berlin had some major challenges. Officials needed to reunite a collapsed socialistic planned economy with low productivity and few competitive products on the Eastern side with a highly subsidized economy on the Western side. As a result of reunification, there was a lot of pressure to find new ways to develop and move Berlin’s unified economy forward.
During the decades since reunification, Berlin’s changed. It has become one of the leading digital hotspots for Europe. It also holds a thriving entrepreneurial ecosystem. Berlin’s startup scene is the largest within the Eurozone and the second largest in the European Union only behind London. Government officials state that every 20 hours a startup is founded within its technology sector. And if the UK completes the Brexit process, Berlin will become the largest startup ecosystem within the European Union too.
But all this incredible growth isn’t coming without highlighting additional challenges. With the attraction and creation of new businesses, the city’s population has grown rapidly over the last 10 years. Housing in Berlin is under pressure as already mentioned — there were no shortage of news headlines about this throughout 2018. This means politicians need to consider how to foster economic growth while continuing to provide a high quality of living. In my opinion, it also means they need to consider looking at their business registration processes and employment regulation.
In Germany the main company form that startups choose is also the most widespread type of company formation in Germany, the Gesellschaft mit beschränkter Haftung or “GmbH”, which translated literally, means a ‘company with limited liability’. For comparision, in the UK the main company form startups tend to choose is the LTD or limited liability company.
As far as European businesses go, both the Germany GmbH and the UK LTD (registered in England and Wales) offer strong international confidence due to the high operational standards applied by the German and British regulators and the established legal framework in both Germany and England.
However, while in Germany having limited liability is ideal for entrepreneurs who want to protect their private assets while projecting a public image of legitimacy to their customers and business partners, the GmbH often presents challenges for founders that ultimately make it less attractive than some other country’s limited liability formations.
German GmbH Challenges:
- High fees for entry in the commercial register (Handelsregister)
- High investment costs: a minimum capital of €25,000 must be available, and at least half of this must be available in the business account at the time of entry into the Handelsregister
- High secondary costs: Consultancy fees for lawyers and tax advisers can cost up to €2,000
- Restrictions on one-person-GmbHs to create capital in the form of contributions in kind, which place a high financial burden on the individual
- In cases of bankruptcy (Insolvenz): Missing capital contributions must be offset by private assets; this becomes especially burdensome for one-person-GmbHs
While some might be thinking “this is great, I know any German company I’m doing business with has a solid foundation!” there are other areas that are holding German GmbHs back.
At the recently held TechCrunch Disrupt Berlin, I attended a panel discussion that addressed fundraising for German startups. One of the biggest hurdles identified was the fact it is so unattractive to issue employee shares from a GmbH. It was felt by panellists that this needed to be addressed by authorities as a matter of urgency to make German businesses even more competitive.
According to the hosts of the session I attended, the law firm Freshfields Bruckhaus Deringer LLP; “employee share plans [in Germany] incentivize, motivate and retain management board members and executive employees, and consequently increase the company’s productivity, but are also seen as a capital investment tool in the current low-interest phase. Compared to other European countries, the total number of participants in employee share plan participants in Germany is relatively small. One key reason is that employee share plans do not provide significant tax benefits under German tax laws (for example, in comparison to Austrian or UK laws).”
- When a startup issues shares in a German GmbH, employee plans can offer both shares and other forms of long-term incentives to provide a mixture of cash and equity-related instruments. Typically, shares are most likely to be offered once a startup has received venture capital funding and the VC helps oversee the development of an employee share plan.
- However, the major downside for executive level-employees in accepting a job where much of the salary is in share options is that there is no specific tax relief for employees regarding share option plans in Germany. This really needs to be revisited by lawmakers because it is a huge hurdle for startups to offer and get employees onto a share plan and there’s a lot of research that shows its good for everyone when employees own a stake in their employer’s company. It also helps startups distribute costs during those critical early years when the finance team prefers to invest cash back into the business to help make it grow.
And finally, it is legal for GbmH’s to offer shares conditionally — meaning they are only exercisable if an employee hits performance targets or time-based vested conditions are met.
The debate at Techcrunch Disrupt Berlin had two main complaints:
- For startups that have not proven they can survive yet while offering largely equity-based salaries, employees said they viewed this as too much risk to accept. Employees weren’t interested in an equity based package because it wasn’t clear if the delayed gratification would pay off. At the same time, if they did manage to make money from shares, the tax rate for GmbH employees was so high that any share amount would have to be large for any serious amount of money to be made for all the hard work completed while deferring total compensation for many years.
- Startup owners complained employees in Berlin just want cash without equity. Some said they try to offer plans, but employees refuse them because the regulations surrounding them are so unattractive (especially in comparison to the US, UK, and Canada).
Let’s take a closer look at GmbH Share Options Plan particulars:
For clarity, the law firm Freshfields Bruckhaus Deringer LLP explains; “the benefit derived from the exercise of share options is generally subject to income taxes and taxed as employment income. The taxable benefit is also subject to a solidarity surcharge and to church tax (if applicable). The taxable benefit is the difference between the exercise price and the fair market value of the shares at the date of exercise (that is, the date when the shares are recorded in the employee’s account).
The benefit is added to the employee’s taxable income and subject to the employee’s individual progressive income tax rate. The highest marginal income tax rate in 2017 is 45%, plus a 5.5% solidarity surcharge levied on the income tax. The church tax rate (if applicable) depends on the religious community and the federal state to which the employee belongs.
The taxable benefit is also subject to social security contributions (different rates apply to pension, unemployment and healthcare insurance). Social security contributions are, however, capped, so that no additional contributions are levied if the total employment income exceeds a certain level per year. The employer and the employee are each liable for half of the contributions.”
Freshfields Bruckhaus Deringer LLP further details regulations for employees selling their shares; “on the disposal of shares acquired on exercise of an option, the capital gain is subject to (privileged) capital gains tax at a flat rate of 25% (plus a 5.5% solidarity surcharge and church tax, if any) provided that the shares were placed in the employee’s account after 31 December 2008. If the shares comprise 1% or more of the company’s total share capital, the employee’s individual income tax rate applies. In this case, 40% of the capital gains are tax-exempt.
The taxable capital gain is the difference between the acquisition cost (that is, the fair market value of the shares at the date of exercise) and the sale price.
If the capital gain from the disposal of shares is paid out or credited by a German financial services institution (or an equivalent institution), withholding taxes must generally be deducted by that institution and paid to the tax authorities. Generally, the tax deduction is final (Abgeltungsteuer). However, on application by the employee, the individual income tax rate can be applied if it is more beneficial to the employee. If no German financial services institution is involved, the employee must declare the capital gain in his or her personal annual income tax return.”
There’s no question that Berlin is a dynamic and vibrant city. The quality of life is good compared to many other cities of its size. But if Berlin’s startup ecosystem wants to really soar in 2019, adjusting its attitude towards copying other businesses, not competing as the cheapest option going, and making its regulatory approach to issuing employee shares more competitive will help the city’s startups achieve even greater success.
Note: I am not a lawyer or financial advisor. The above article is opinion and does not constitute legal or financial advice. Portions of regulation text have been quoted for accuracy from Freshfields Bruckhaus Deringer LLP’s guide Employee Share Plans in Germany openly published on Thomson Reuters’ Practical Law. Should you have any legal or financial questions, the appropriately qualified professional should be consulted.
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