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Employee share option plans (ESOP) are share schemes that startup owners can use to incentivise their key employees to maintain their performance. An ESOP gives employees, including overseas employees or contractors, the right to purchase options in your company. This means that your overseas employee or contractor gains the right to purchase shares in the future. This article will explain how ESOPs work and how you can offer them to overseas employees and contractors.

Why Implement an ESOP?

Share schemes have become commonplace for startups who cannot offer their staff a salary that rivals other established corporations. As such, ESOPs offer an employee share options in a company which will hopefully be of greater value in the future when the company achieves an exit event. 

An exit event is when you decide to sell or change who controls your startup. It signals the ‘exiting’ of ownership.

If your company does not aim to achieve an exit event, an employee with shares will likely share in the company’s profits through dividends. 

One of the key reasons ESOPs have become so popular with Australian startups is the tax concessions available to eligible startup employees. Generally speaking, if your startup is eligible, your participating employees will not have to pay tax when they: 

  • receive their shares or options; or 
  • exercise their options. 

Nevertheless, tax implications are only triggered when your employee decides to sell their shares. Furthermore, an employee may be eligible for the Capital Gains Tax discount provided they have owned the shares for over 12 months.

How to Implement an ESOP 

When it comes to implementing an ESOP, you should keep the following steps in mind. 

1. Seek Approval

To implement an ESOP, you must seek approval from key individuals within your company. You will likely need to seek approval from your board or shareholders (or a combination of the two) depending on your company’s constitution and shareholders’ agreement. 

2. Draft Your Plan Rules

The main document in an ESOP is known as the Plan Rules. Your Plan Rules will set out the structure of your company’s ESOP. Additionally, the Plan Rules will dictate rights and obligations such as:

  • employee eligibility;
  • vesting conditions; and
  • what will happen in the event an employee leaves the company.

3. Make Your Offers to Overseas Employees

You must then make individual offers to your employees to participate in your company’s ESOP scheme. Using an ESOP offer letter, you should set out the key terms on which you are offering your employee to participate in the company’s ESOP. These terms include: 

  • the number of options you are offering your employee; 
  • the price your employee must pay to exercise those options; and 
  • any vesting conditions which their options are subject.

Vesting

It is common amongst businesses to have vesting provisions in their ESOPs. Typically, vesting provisions subject the employee’s options to a milestone or time-based release mechanism. As a result, an employee may have to surrender any options that remain unvested at the time of the employee’s departure from the company.

Although vesting can be milestone based, they are commonly time-based. Usually, the typical vesting period is four years with a one-year cliff. The cliff is the minimum period in which your employee must continue their employment before their options begin to vest. Once over the cliff, the employee’s remaining options vest monthly or quarterly. 

Offering ESOPs to Overseas Employees

Generally speaking, your employee does need to be an Australian resident to own shares or options in an Australian company. Since the number of options you issue under a share scheme should be a small percentage of your company’s shares, they should never reach the change in control threshold which would trigger a review by the Foreign Investment Review Board (FIRB). As such, unless your company is a national security business, there is nothing that prevents an overseas employee from owning shares or options in your Australian company. 

Tax Implications for Overseas Employees

Suppose your overseas employee is not an Australian resident for tax purposes. In this instance, they may still have to pay tax in Australia concerning any ESOP interests your company has issued to them. 

The tax implications for your overseas employees’ will largely depend on: 

  • whether or not their options have vested; and 
  • whether their country of residence has a tax treaty with Australia called a Double Taxation Agreement (DTO). 

As taxation is a complicated area, you should encourage your overseas employee to get tax advice both in their country of origin and in Australia. 

A Guide to Employee Share Schemes

LegalVision’s Employee Share Schemes Guide is a comprehensive handbook for any startup founder or business owner looking to attract and motivate top employees with an Employee Share Scheme.

Download Now

Key Takeaways

ESOPs are common tools employers use to incentivise and retain key talent for their startups. Nothing is stopping you from issuing ESOP options to your overseas employees. However, your overseas employees may require independent tax advice in Australia and the country they reside in for taxation purposes. If you are interested in offering shares under an ESOP to your overseas employee or contractor, our experienced startup lawyers can assist as part of ou LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page

Frequently Asked Questions

Do I have to record options I issue to employees?

Yes. Once your employee accepts an offer under your ESOP, you must record the issued options in your company’s options register.

Can I offer options to people other than employees?

You can make offers under your ESOP to contractors or directors that your company engages.

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