Employee Share Schemes (ESS) provide a means for startups to offer shares to their employees, or options to purchase shares. In July 2015, the Australian Taxation Office changed the tax treatment of ESSs to make them more attractive to employees. As a result, an increasing number of employers now offer ESSs. Below, we unpack five key components of an ESS. This article assumes the startup is issuing you with options rather than shares.

1. Options

Under the terms of an ESS, an employer will offer you options to buy shares in a company. An option is a right, but not an obligation, to purchase shares in a company. An option will delay the creation of a share until a future date.

2. Vesting

Generally, options vest based on the length of an employee’s service to the company. The standard time frame is between three to five years with options vesting at various intervals during this time. For instance, imagine shares vest 25% for each year the business employs the employee over four years:

  • 25% after one year;
  • 50% after two years;
  • 75% after three years; and
  • 100% after four years.

The employee can only exercise their options (i.e. purchase shares in the company) once all options have vested. If the employee leaves the company before the options have vested, the options will lapse. Also, the employee may have to sell some or all of their vested options.

3. Exercise Price

The ESS documents will set out the price that the employee must pay to exercise its option (also known as the exercise price or strike price).

To benefit from the ATO’s tax concessions, the exercise price must be at least the fair market value of a share in the company on the date the startup granted the option. A company can calculate the fair market value using one of the two safe harbour valuation methodologies.

Buying shares is risky. Each shareholder hopes that as the company grows, so too will the value of the shares. Under an ESS, an employee retains the option to buy shares at the exercise price which, hopefully, will be far less than the current market value and so will make a profit when they decide to sell.

Importantly, while the employee has options, they don’t have voting rights or the right to dividends.

4. Disposals

The employee will need to hold the options or shares for at least three years to benefit from the ATO’s startup tax concessions unless they leave the company or in other limited circumstances. Employees do not usually dispose of their options or shares unless there is an exit event.

When an option holder exercises their option and purchases shares, they will need to either:

  • enter into a shareholders agreement; or
  • sign a deed of accession agreeing to be bound by the terms of the shareholders agreement.

Once the option holder becomes a shareholder, then the shareholders agreement will govern any disposal of shares.

5. Eligibility Criteria

A startup must first meet certain criteria to qualify for the ATO’s startup tax concession. Namely, a startup must:

  • be an Australian company, with at least one director that is an Australian resident;
  • not be listed on a stock exchange;
  • not be incorporated for more ten years; and
  • have an aggregate annual turnover of less than $50 million.

As mentioned, the exercise price should reflect the market value of the shares at the date the company granted the options.

The employee must also satisfy certain criteria, including:

  • holding the options of shares for at least three years; and
  • an individual employee cannot hold more than 10% of the company.


If you have received ESS documents from your employer and have questions about how it works, get in touch with our specialist startup lawyers on 1300 544 755.

Jill McKnight
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