An employee share scheme (ESS) is a plan that can offer eligible employees shares or options in your company. An ESS is becoming an increasingly popular choice as a potentially tax-friendly method (depending on your eligibility) of attracting and incentivising employees. This article will provide three tips for a startup’s ESS, after providing a background of the startup and ESS environment.

Your Startup’s ESS

It is every startup founder’s goal to have an engaged and committed team that will go the extra mile. An ESS has the potential to provide your company’s employees with a tangible sense of commitment. If your company’s value increases, so does the value of the shares on issue. Strategically, an ESS can be part of your broader employee engagement and recruitment strategy as your startup grows.

Not every company or employee is eligible for a startup tax concession ESS. It is important to review your eligibility before setting an ESS in motion.

An ESS can offer eligible employees either shares or options in your company. The difference between holding shares in a company and holding options is that once you are issued with shares, you become a shareholder. This involves accepting the rights and responsibilities of a shareholder.

However, as an option holder, you are not a shareholder, but rather someone with an opportunity to purchase shares (known as an ‘option’ or ‘call option’) once the conditions to ‘exercise’ the option are met. Once an option holder has ‘exercised’ their option, they become a shareholder in the company.

The below three tips will ensure you can implement your startup’s ESS as smoothly as possible.

1. Manage Your Option Holders Register

As a company, you are required by law to keep your register of option holders up to date within 14 days of granting new options. Accordingly, it is vital that you have processes in place to keep track of your option holders. You must also update the Australian Securities and Investments Commission (ASIC) in time as options holders change.

As your option holders exercise their options and become shareholders, you will need to update your:

  • option holders register; and
  • members (shareholders) register.

2. Remember the 50 Shareholders Rule for Proprietary Companies

ASIC requires proprietary companies have no more than 50 shareholders. If you are a proprietary company, ensure that your ESS addresses this issue proactively to prevent breaching this rule.

For example, your ESS may prevent an option holder from exercising their options if that would cause the company to have greater than 50 shareholders.

You may also wish to prescribe that the company is not permitted to take any action that would cause the company to have more than 50 shareholders. Such an event may be caused by issuing, redeeming or buying back option shares.

3. Grant Options Methodically

We recommend that you grant options at strategic intervals. For example, you may wish to grant options once a year. You may select the date of granting options to coincide with the end of performance reviews, for example, so that you can reward high performers with options in the company.

If you grant options on an ad-hoc basis, this may cause an administrative burden. Further, if you grant options at various points during the year, you will have various vesting dates of which to keep track in order to effectively manage your startup’s ESS.

Once you have determined when you will grant options, you may also wish to consider vesting at longer intervals. For example, instead of shares vesting on a monthly basis, you may extend this period by a reasonable stretch to a quarterly basis. This simplification of your startup’s ESS administration may assist you to manage your scheme effectively and get back to what matters: growing your startup!

Key Takeaways

An ESS is not a one-size-fits-all approach for companies or their employees. It is important to consider what will work for your specific situation. However, an ESS can be a vital employee retention and recruitment strategy if you are considering how best to engage your team for long-term success. Ensure that your startup’s ESS is managed effectively, as ASIC requires companies to meet various reporting obligations.

Are you a startup that needs more information about how an ESS works? Or need help implementing one? Get in touch with LegalVision’s startup lawyers on 1300 544 755 or fill out the form on this page.

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