Sweet equity

Hungary

Managers of a company are typically allocated "sweet equity" to incentivise future performance which will need to be carefully structured from a tax law perspective in order to avoid dry income taxation. You may be allocated some as a founder if you are staying on in the business. This gives managers a financial stake in the business and incentivises them to grow the company because they will then receive significant returns on an exit for a low investment cost (i.e., it "sweetens" their deal with the company). PE investors will set aside a "pot" or "pool" (a certain number of reserved shares) of sweet equity on completion of a transaction so that any existing and future managers can be allocated shares. Sweet equity shares generally have limited rights and protections. For example, you may not have any voting rights nor any rights to receive distributions, and you will likely be required to sell your sweet equity if you leave the company prior to an exit (and will get different amounts for it depending on how you leave, for example as a "good", "bad" or "intermediate" leaver – for more on these terms see the table here). The taxation of a sweet equity structure typically depends on the exact structure and design and may give rise to a flat income tax taxation of future dividends and capital gains. Improper structuring may result in the entire benefit being reclassified as employment income, subject to progressive taxation under Hungarian law. By contrast, where the structure is properly implemented (i.e., where market value is paid for the interest acquired and entrepreneurial risk is genuinely assumed) any future proceeds may qualify as capital income, subject to flat-rate taxation under the capital gains or dividend tax regime.