Photo: Fabio Rodrigues Pozzebom/Agência Brasil

Legal Framework for Startups: We need to resume the stock options proposal for startups in Brazil

Kiko Afonso, CEO at Grupo Dínamo, a public policy advocacy group for Brazilian startups, shed a light on the importance of stock option plans to leverage the innovation and startup ecosystem in the country

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We have been waiting for this moment for years. The creation of a Legal Framework for Startups that could in fact represent the wishes of the ecosystem and the much-needed regulation that could put us at world levels.

There was no lack of contributions, arguments, and references to support the sector’s requests, but what we see in the end is an outdated Startups Legal Framework, which does not really change the rules of the game for startups in Brazil and keeps us far behind the rest of the world on several fundamental issues.

Even with some advances, what is in place does not help to reduce the pace of the widening gap that keeps us apart from other countries that treat Innovation and Technology strategically. 

READ ALSO: Brazil’s Legal Framework for Startups has green light from the country’s Senate; ecosystem remains unmet

From the four main points requested by the ecosystem, in agreement, I want to address one in particular so that we can understand the depth of the delay we are experiencing and the impact that this point brings to the economy and the future of the country.

Among the topics regarding joint-stock companies being eligible for the simplified tax system (known in Brazil as Simples Nacional); tax equivalence for angel investment; and stock options, I chose the latter to exemplify why the sector is deeply dissatisfied with the lack of this item in the Legal Framework.

Senate President Rodrigo Pacheco chairs a session to analyze the Legal Framework for Startups in Brazil. Photo: Fabio Rodrigues Pozzebom/Agência Brasil

To put the impact in context, we need to understand the circumstances of employment in the world today. More than half of the new jobs generated worldwide come from emerging companies with high growth potential, which are companies that grow at least 20% a year, according to the OECD.

The vast majority of these companies are startups and in Brazil, we have several successful examples, such as iFood and Nubank, considered unicorns – companies valued at more than US$ 1 billion.

However, before becoming giants, these companies were startups, with a small group of entrepreneurs who got together around an innovative idea. And the life of a startup, as we know, is not easy at its beginning. There is a shortage of everything, resources, support, and especially labor force.

READ ALSO: Startups Legal Framework Bill recognizes the importance of the sector in Brazil but leaves tax and labor issues behind

Who works with technology currently in the country knows that hiring a good professional in the area can be as difficult as winning the lottery, and to create innovation it is necessary to have highly qualified people on the team.

The current demand for professionals per year is more than 70,000 professionals, but Brazil only trains 46,000 per year, according to Brasscom (Brazilian Association of Information Technology and Communication Companies), a deficit of more than 24,000 professionals per year. And yet according to IDC, a global consulting firm for the technology markets, the IT market, globally, will have a deficit of 570,000 professionals by 2020 alone. 

This situation spells out a very serious problem for startups: how to hire a highly qualified labor force in a market with a general shortage of professionals and still compete with large corporations that are able to pay high salaries and offer solid benefits?

In their beginning, without access to resources to offer salaries competitive with large corporations to attract qualified talent, startups, worldwide, offer the professional the possibility to bet on success and grow along with the company. 

The stock options tool represents exactly this for startups. 

One can clearly see how important for innovation it is the possibility of startups being able to compete for the labor force.

READ ALSO: IDB Lab: Latin America and the Caribbean startup ecosystem has the potential to reach over $2 trillion by 2030

It gives the highly qualified professional, who is fully capable of having a job in a large company and earning a higher salary, the possibility of betting on the success of an emerging company, giving up the gains that they would have in the short term in a large company, betting on the potential success of the potentially exponential growth of a startup, bringing to it their qualified knowledge.

One can clearly see how important for innovation it is the possibility of startups being able to compete for the labor force to create disruptive products and services.

Going a little deeper, the stock option is nothing more than an option to buy a company’s stock under pre-established conditions, such as, for example, at a discounted price when the option is exercised, among several other ways, so that when the stock option is exercised in the future, the startup will potentially be worth much more, generating gains for the employee. 

Whatever the format, the stock option is a bet, of those who get paid, on the future success of the company and is at the risk of the business, since it may become worthless if the company fails. Its value at the time of issue is practically nothing, because in the initial stage the startup is incipient, seeking to prove itself, and at high risk of failure.

Only when the person who receives the stock option actually exercises it, in a future moment, assuming that there has been success and growth of the company, will that employee have actually received something of market value, in this case, shares of the company with a market value higher than the price of the stock option. 

In this sense, the Legal Framework for Startups brought a positive draft in its beginning, contributing to the regulation of a tool already widely used by the sector, but subject to huge legal uncertainty, since, without regulation, the remunerative or commercial nature of the stock options is at the mercy of a judge’s interpretation.

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However, the draft proposed by the ecosystem was changed in the lower house, giving the stock options a remunerative character, that is, incorporating the option as if it were “part of the wages,” with taxes and labor charges levied on something that those who receive and those who offer don’t even know if it will have any value in the future. 

The changes, unfortunately, were sent to the Senate, which, lacking the political strength to change the draft sent by the lower house, opted to completely remove the article on stock options from the draft. 

In the end, and given the conditions, it was the best solution since it is better to have no regulation and keep the current rule of legal uncertainty than to create a regulation that solves the insecurity by leaning towards the most harmful and costly interpretation for startups. 

We need to resume the stock options proposal for startups at the risk of imposing yet another barrier for innovation to emerge in the country. 

Without talent, there is no innovation. Without innovation, there are no new high-growth companies. Without high-growth companies, we will have far fewer jobs.

It is not hard to understand this issue, what is missing is political will and an eye to the future.