Sweet equity and the proposed change to the lucrative interest scheme

It actually sounds appetising; sweet equity. It often is, which is partly why this form of executive remuneration is widely sampled. But what is it really? And given the possible upcoming tax changes, will it still be so 'sweet' to keep this equity?

Sweet equity

So-called sweet equity is often offered to incumbent or joining directors of a company. Especially in a management buyout (MBO) and in private equity structures, this variant is common. Essentially, the portion of capital (equity) that the directors hold in the company compared to the (private equity) investor is issued to the management of the company at a (significantly) lower investment. In this way, management is not only tied to the company because it holds capital, it is also an incentive for management to deliver good results. After all, management shares in this directly, either in the form of dividends or in the form of higher proceeds in the event of an exit (sale of shares).

Sweet equity can often be issued by optimising the company's mix of equity and debt. In this way, the company can have such debt that the issue price of the manager's share becomes low compared to the investment requested from the investor. This also directly increases the leverage of the invested equity. Simply put: low investment, high returns for the directors.

The investor will often 'insure' his own higher stake through preference shares; these shares give the investor priority over distributions and sale proceeds. In this way, the investor secures that his deposit (often with a certain multiple) will be returned. But if high sales proceeds are realised - and that is the starting point - the management shares in the surplus profit.

Change lucrative interest scheme

For tax purposes, income from a lucrative interest falls in principle in box 1, but this income can be moved to box 2 under certain conditions. Conditions include that the managers concerned hold the shares through a personal holding company. On 3 July 2025, the House of Representatives voted in favour of a motion increasing the substantial interest rate (24.5% up to EUR 67,804 and 31% from EUR 67,804 onwards, respectively), probably with effect from 1 January 2026. The exact rate is not yet known, but it is reckoned to be 36%. The regulation was specifically written with sweet equity structures in mind. Of course, this does not immediately make it unattractive to acquire sweet equity, but it does make it less attractive to participate through this type of scheme. Several alternatives are available, and it is important to let the tax specialist determine which variants are attractive from a tax point of view. For example, an amount taxed in Box 1 may well be deductible for corporation tax, and depending on the percentages held, interests held may be taxed in different boxes.

Alternatives

It is obvious to identify and consider alternatives when determining the form of management remuneration. Here, too, a tax expert's assessment will be important. Below, we briefly discuss some alternatives.

Depositary receipts for shares

Sweet equity, for the purpose of control rights, is regularly offered to management in the form of depositary receipts. Whether depositary receipts are also a fully-fledged alternative from a tax point of view must be determined independently; depositary receipts of shares occur in box 3 or box 2, depending on the size of the interest held.

Compared to the 'usual' and classic division of equity between a (private equity) investor and management (often a mix of preference shares and ordinary shares), depositary receipts do occupy a different place. After all, they separate the economic ownership from the legal ownership of the shares. In short, this places voting and meeting rights not with the depositary receipt holders, but with a Stichting Administratiekantoor (STAK). On the basis of beneficial ownership, the depositary receipt holders do receive the monetary reward, which is of course what this type of arrangement is all about.

The rules surrounding depositary receipts are usually set out in the STAK's administration conditions, any participation rules and possibly still individual participation agreements.

Stock appreciation rights (SAR) / Phantom stock

As the arrangements of Stock Appreciation Rights (SAR) and phantom stock are almost identical, we treat them together here.

SAR are effectively nothing more than contractual claim rights. The claim that management obtains is based on the movement in value linked to a share in the company. So if the share price changes from, say, EUR 40 to EUR 50 in a year, the manager is entitled to EUR 10 per SAR held. A SAR thus differs little from a cash bonus; after all, that is also a contractual entitlement to payment of a sum of money after a certain period has passed and certain conditions have been met. The big difference with the cash bonus, of course, is that SARs will fluctuate; after all, they follow the price movements of the company's shares. But that also means: more results = more appreciation = more bonus.

For SAR, a SAR Plan and individual participation agreements are generally drawn up. In these, agreements can also be made on, for example, vesting of the SAR or a lock-up arrangement, so that a manager remains tied to the company even in this way (in the absence of ownership of a 'real' share).

Cash bonus

The cash bonus is actually self-explanatory; the bonus is paid under certain conditions after the expiry of a certain term. Usually, the bonus is included in an employment contract and/or employee handbook. While a bonus can of course be higher if certain KPI are met, it is likely to fluctuate less than a SAR.

Sweet equity: where to go from here?

Sweet equity was and is an important tool for both (private equity) investors and managers to give management an incentive to (i) be tied to the company and (ii) pursue good results. As the lucrative interest scheme may become less interesting fiscally, our expectation is that alternative structures will at least be explored more seriously. Several alternatives are worth considering, with a tax expert's judgment and calculation always leading the way. The various variants all have their own characteristics and advantages and disadvantages.

There is no doubt that the sweet equity regime will sour somewhat for unitholders in the short term. The good news is that there are plenty of alternatives worth exploring and calculating. That way, (future) managers in a participation scheme can make their equity or equivalent as sweet as possible. Or in other words, "when life gives you lemons, make lemonade.

Pieter Verloop

At Marxman Lawyers, we understand that changes to the lucrative interest regime have major implications for managers and investors. We help retain existing sweet equity as well as legally set up alternatives such as certificates or SAR schemes.

Marxman Advocaten does not provide tax advice, but works closely with tax specialists and other specialists. We thus ensure a watertight legal structure in which all interests are safeguarded.

Want to know which solution is best in your situation? Contact Pieter Verloop, Sebastiaan Palm, Dennis Kok or Margreet van de Vuurst from the M&A team at Marxman Advocaten.