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In March 2022, the government announced reforms to make it easier for businesses to utilise employee share schemes (‘ESS’) and reduce the red tape so that employees at all levels can directly share in the business growth they help to generate. These changes include:

  • amending the disclosure rules, allowing unlisted companies to offer an unlimited number of shares, of an unlimited value, as long as the employee is not charged more than $30,000 a year for them (up from a $5,000 a year cap). Employees will also be able to accrue up to $150,000 over a five year period; and

  • for employee share schemes where there is no payment to participate, independent contractors will receive the same treatment and receive the same regulatory relief as employees and directors who are participants in the scheme.

An Employee Share Scheme (ESS) provides 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. This article will unpack five key components of an ESS when 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 your service to the company. Vesting refers to the time period after which you can act on and sell your shares. The standard time frame is between three to five years with options vesting at various intervals during this time.

For example, if shares vest at 25% for each year that you are employed, you will be able to sell 100% of your shares after four years:

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

You can only exercise your options once all options have vested. If you leave the company before the options have vested, the options will lapse. Also, you may have to sell some or all of your vested options.

3. Exercise Price

The ESS documents will set out the price that you must pay to exercise your option. This is 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, you retain the option to buy shares at the exercise price which, hopefully, will be far less than the current market value. Therefore, you will likely make a profit when you decide to sell.

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

4. Disposals

You will need to hold the options or shares for at least three years to benefit from the ATO’s startup tax concessions. This is unless you leave the company or in other limited circumstances. However, you will not usually dispose of your options or shares unless there is an exit event.

When you exercise your option and purchases shares, you 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 you become a shareholder, 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.

You must also satisfy certain criteria, including:

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

Key Takeaways

If your employer has given you the option of participating in an ESS, you should be aware of its important components. These include the:

  • options;
  • vesting dates;
  • exercise price;
  • disposals; and
  • eligibility criteria.

If you have received ESS documents from your employer and have questions about how it works, get in touch with LegalVision’s startup lawyers on 1300 544 755 or fill out the form on this page.


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