EMPLOYEE

SHARE SCHEMES
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CONTENTS
About this Guide 03

1. Is My Startup Eligible for the Startup Tax Concessions? 05

Company Criteria for Startup Tax Concessions 05

2. Is My ESS Offer Eligible for the Startup Tax Concessions? 06

ESS Offer Criteria for Startup Tax Concessions 06

3. How Do I Implement an ESS? 07

4. What Key Terms Should an ESS Offer Include? 08

Employee Share Plan & Employee Share Option Plan 08

Specific Terms in an Employee Share Plan 11
Specific Terms in an Employee Share Option Plan 11
How to Exercise an Option 12

5. How Are Shares Valued for an ESS? 13

Net Tangible Assets Test 14

Final Checklist 16

How Can LegalVision Help? 17

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ABOUT THIS GUIDE

As a startup founder, you want the best person for the job,
in the job. But, unless you have raised plenty of capital, it is
unlikely that you can pay top dollar for your team members.
An Employee Share Scheme (ESS) is one way to attract and
incentivise talent by offering a tax-efficient ownership interest
in your company.

Under an ESS, you can offer employees shares, or options to

buy shares, in your company. In our experience, most startups
structure their ESS as an Employee Share Option Plan
(ESOP) because unvested options are simply cancelled if an
employee leaves and there is no need for the company to go
through a share buy-back.

This guide explains the shared features and key differences

between a share scheme and an option scheme. We also
set out the five questions founders looking to set up an ESS
should work through to ensure compliance with Australia’s
tax laws:

1. Is my startup eligible for the startup tax concessions?

2. Is my ESS offer eligible for the startup tax concessions?
3. How do I implement an ESS?
4. What key terms should an ESS offer include?
5. How do I value my shares for an ESS?

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A few definitions to help guide
you through this guide:
• Accounting Standards – Standards that
the Australian Accounting Standards Board
(AASB) set to regulate financial reporting.
An accountant must prepare the financial
report to ensure it complies with the standards.
• ESS Interest – A share, or the option to buy
shares, in the company.
• Exit Event – An Exit Event is one of
the following:
1. An initial public offering of the shares
in the company on a stock exchange;
2. A sale of the shares of the company; or
3. A sale of the business (i.e the assets)
of the company or Subsidiary Company.
• Group Company – Refers to the following:
• a subsidiary of your company; or
• your company’s holding company; or
• a company which is a subsidiary of the
holding company.
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• Incorporation – The creation of a company.
In Australia, this involves registering the
company with the Australian Securities and
Investments Commission (ASIC).
• Option – A right to buy shares in the company
at a future date at a pre-fixed price.
• Ordinary Share – A share in the company that has
standard terms, rights and privileges (e.g the right
to vote and receive dividends).
• Preference Share – A share which has preferential
terms, rights and privileges when compared to
ordinary shares.
• Small Business Entity – A company that has
an aggregated turnover of less than $2 million.
• Subsidiary Company – A company owned or
controlled by another company (known as the
holding company). A company is a subsidiary
if the holding company:
• controls the composition of the subsidiary’s
board; or
• controls 50% of the votes at the subsidiary’s
general meeting; or
• holds more than 50% of the shares in
the subsidiary.
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1. IS MY STARTUP ELIGIBLE FOR

THE STARTUP TAX CONCESSIONS?
A key reason why ESSs are so popular with startups is the
special tax concessions that are available to the employees
of eligible startups. If your startup meets the eligibility criteria
A key reason why ESSs are
below, your employees will be taxed only when they make a so popular with startups is
financial gain (i.e. profit) from their ESS Interests. Usually, this
happens when they sell their ESS Interest. the special tax concessions
In other words, your employee will not have to pay any
tax when they receive their shares or options, when their
shares or options vest or when they exercise their options
(i.e. buy shares).

Company Criteria for Startup Tax Concessions

Shares Cannot Be Listed Your company’s shares, and the shares of any
on a Stock Exchange Group Company, are not listed on a stock exchange.

Company Incorporation Your company, and all Group Companies,

was incorporated in the last 10 years.

Aggregated Turnover In the previous income year, the aggregated turnover

of your company, and all Group Companies, was less
than $50 million.

Australian Residency The employing company was incorporated in Australia.

Company’s Predominant The company’s main business is not investing in other

Business shares or investments (e.g. an investment bank).

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2. IS MY ESS OFFER ELIGIBLE

FOR THE STARTUP TAX CONCESSIONS?
If your startup is eligible based on the previous criteria, you also need to make sure
that the actual offer of the ESS Interest is eligible for the startup tax concessions.

ESS OFFER CRITERIA FOR

STARTUP TAX CONCESSIONS

Employee’s You can only grant ESS Interests to employees of your company or a
Status Subsidiary Company. Here, an employee includes contractors and directors.

Operation Your employee must hold the ESS Interest for:

of the ESS • three years (unless the business is sold or listed); or
• until your employee stops working for your company.

Type of Shares The ESS Interest must be ordinary shares, or an option to acquire ordinary
shares. An ordinary share gives the shareholder the right to vote on matters
put before all of the shareholders of the company.

Percentage of The employee does not:

Shares Held • hold more than 10% of the shares in the company; or
• control more than 10% of the vote at a general meeting.

Exercise Price For options, the price to exercise the option must be at least the value of an
ordinary share in your company at the time when you granted the option.

For Shares Only:

Discounted For shares, the share price must be at least 85% of the value of an ordinary
Shares share in your company at the time when you issued the shares.

Share Plan For shares, the company must offer the plan to at least 75% of its Australian
Access employees who have been with the business for at least three years.

If you do not satisfy the criteria, you can still access some tax concessions through alternatives such as a
deferred-tax share plan. A deferred-tax share plan permits your employee to defer paying tax on their ESS
interest until a later point in time. If you would like to discuss your eligibility for this plan, please get in touch.

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3. HOW DO I IMPLEMENT AN ESS?
Once you have determined your eligibility, you can then offer
ESS Interests to your employees. In most cases, you will need
to take the following steps:
Step 1
The shareholders, the board of directors, or
both must approve the company implementing
the ESS and the Plan Rules which govern the
ESS. The company constitution or shareholders
agreement will set out the type of approval
you require.
Step 2
The board of directors will pass a resolution
to approve an offer of shares or options to a
particular employee.
Step 3
The company will then prepare and send to
the employee:
• an offer letter. The letter will set out the
number of shares or options that you are
offering to the employee, the price (or
exercise price), and vesting conditions; and
• the plan rules which govern the ESS. The
plan rules will cover what happens to an
employee’s shares or options if they stop
working for the company and, for option
plans, how and when they can exercise
their options.
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Step 4
The employee accepts the offer by
signing the offer letter and returning
it to the company.
Issuing Options Under an ESOP
1. Update your company’s optionholders’ register.
2. Update your company’s capitalisation table
(cap table).
OR
Issuing Shares Under an ESS
1. Your employee pays for the shares at the time
of accepting the offer.
2. Employee signs a deed of accession to the
company’s shareholders agreement (if it
has one).
3. Update your company’s members’ register and
issue your employee with a share certificate.
4. Update your company’s cap table.
5. Notify ASIC.
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4. WHAT KEY TERMS

SHOULD AN ESS OFFER
INCLUDE?
When you issue an ESS Interest, the ESS documents should
contain certain key terms. The terms of the documents will
differ depending on whether you are implementing a share
plan or an option plan. We have set these out below along
with some recommended standards.

Employee Share Plan &

Employee Share Option Plan
Vesting
Vesting is the process through which your
employee earns their shares or options.
Most commonly, the shares or options
are earned over time, but you can also
set performance-based milestones.
If you would like vesting to apply, the
plan rules or offer letter should set out:
• The vesting schedule. A four-year vesting
period with a one-year cliff is a standard
time-based vesting provision for startup
employees. A one-year cliff means that if
the recipient leaves the company within
12 months of being issued shares or options,
they will have to forfeit all of their shares
or options.
• What happens to unvested shares
or options when an employee leaves
(e.g. will unvested options be cancelled
and will unvested shares be bought back
by the company)?

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Disposal
To be eligible for the startup concessions,
an employee must hold their shares or options:
1. for at least three years from the date of issue
(unless there is an Exit Event, in which case
the ATO can approve a shorter period);
or (if earlier)
2. until they stop working for your company.

Exit Event
Under the plan rules the Board is given discretion
to decide what happens at an Exit Event.
Generally unvested shares or options are either
cancelled (for options) or bought back for nominal
value (for shares) or have their vesting accelerated
(i.e. the vesting conditions are waived by
the company).
Generally vested options must be exercised prior
to the Exit Event and the shareholder can then
participate in the Exit Event.

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Leaver Provisions
The plan rules will set out what happens to the
employee’s shares or options if the employee is a
‘Leaver’. A Leaver is someone who stops working
for the company for any reason.
Under the plan rules, the board is given flexibility
to decide what happens to the shares or options
of a Leaver.
Most commonly, any shares or options that have
vested will either be:
(i) retained by the employee; or
(ii) sold for their fair market value.
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Any shares or options that have not vested would
generally lapse (for options) or be bought back for
nominal value (for shares).
When buying back shares, the company must
follow the correct legal process. There might also
be tax implications for the employee. The process
will differ depending on whether the shares are
being bought by shareholders or by the company.
In most cases, it will require a number of legal
documents as well as the necessary updates to
the company’s members’ register and ASIC.
For an option to lapse, the company will present
the employee with a lapse notice and update its
optionholders register.
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Specific Terms in an Employee

Share Plan
Price
This is the price the employee must pay to
acquire the share.
The price must be at least 85% of the value of
an ordinary share to be eligible for the startup
tax concessions. You may be able to calculate
this by using the net tangible assets test below.

Specific Terms in an Employee

Share Option Plan
Exercise Price
The exercise price (or strike price) is the price
that an employee must pay to exercise their
option and acquire a share. Your startup sets
the exercise price when you grant the option
based on the value of an ordinary share at that
time. Again, you may be able to calculate this
using the net tangible assets test on page 15.
If your company’s value increases and the share
price exceeds the exercise price, your employees
can acquire shares in your company at a discount.

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How to Exercise an Option
The plan should set out whether the optionholder can
exercise their options:
• any time after they have vested; or
• only on an Exit Event.
The plan can also set an expiry date for the options
(i.e. the last date an employee can exercise their options).
What an Employee Should do
In either situation, your employee should:
• give the company a signed notice indicating that they
are exercising their option; and
• pay the exercise price, multiplied by the number of
options they are exercising. For example, if the exercise
price is $5, and the optionholder has 20 options, if the
optionholder wants to exercise all its options it must
pay $100 ($5 x 20); and
• sign a deed of accession to the company’s shareholders
agreement (if it has one).
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Even where employees are able to exercise an option as
soon as it has vested, options are most commonly exercised
at an Exit Event so the employee can determine whether
the value has increased and whether they want to pay
the exercise price.
What a Company Should Do
When your employee exercises their options, the company
issues them with their shares by:
• preparing resolutions/minutes;
• issuing a share certificate to the employee;
• updating its members’ register; and
• notifying ASIC.
The number of shares should be equal to the number
of options that are exercised.
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5. HOW ARE SHARES

VALUED FOR AN ESS?
Once you have determined that your startup and and ESS
offer qualify for the startup tax concessions, you must
work out the value of an ordinary share in your company.
This is important because it will determine how much
your employee pays to either acquire the share,
or exercise the option.

The ATO has issued two valuation methodologies

which startups can use to value their shares for an ESS:

1. a formal valuation; and

2. a net tangible assets test.

The net tangible assets test for startups typically produces

a lower valuation, meaning your employees pay less to
acquire or exercise their ESS interests, but you must meet
the eligibility criteria if you wish to use this valuation.

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Net Tangible Assets Test Under the net tangible assets test, a startup’s valuation can
be calculated using the following formula:
Because startups tend to have few, if any, tangible assets,
the net tangible assets test enables you to issue shares or
grant options with a share or exercise price that is lower
(A - B) / C = Valuation
than the share’s market value.

To use the net tangible assets test, you must determine your
• A= refers to the company’s net tangible assets
startup’s eligibility for tax concessions using the checklist
at that time (disregarding any preference shares
above, and satisfy the criteria set out in the flow chart on
on issue);
the next page.
• B =refers to the total amount of money your
preference shareholders would make on their
shares, if you redeemed, cancelled or bought
The net tangible assets test them back today; and

enables startups to issue shares • C = refers to the total number of shares on issue
in the company
or grant options with a share or
exercise price that is lower than
the share’s market value

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Net tangible assets test criteria

Using the checklists on pages five and six, have you determined that
your company is an eligible startup for the tax concessions?

Yes

Does your company anticipate a change of

control in the next six months?

No Yes

Has your company raised more than Not Eligible

$10 million in the last 12 months?

No Yes

Has your company been incorporated Not Eligible

for more than seven years?

Yes No Will your company prepare a financial report

for the year that complies with the Corporations
Act accounting standards?

Is your company a ‘small business entity’ (i.e. has

an aggregated turnover of less than $10 million)?
No Yes

Not Eligible Eligible

No Yes

Not Eligible

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FINAL CHECKLIST

Checklist

Confirm the company is eligible for the startup

tax concessions.

Decide whether you are going to offer your

employee shares or options.

Have the appropriate ESS documents drafted

(offer letter and plan rules).

Get the necessary approval from the board

and/or shareholders to implement an ESS.

Check whether you are eligible to use the

net tangible assets test.

Determine the share price or exercise price

for the offer you are making.

Determine what vesting conditions will apply

to the employee (if any)

When you’re ready to issue the shares or

options, confirm the offer you are making is
eligible and get approval from the board for
the particular offer

Provide your employee with their offer.

Once accepted, take the necessary steps

to issue the shares or options.

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HOW CAN
LEGALVISION HELP?
LegalVision is a market disruptor in the commercial legal
services industry. Our innovative business model and custom-
built technology assist our lawyers to provide a faster, better
quality and more cost-effective client experience. LegalVision
is a leader in delivering legal services in Australia and has assisted
more than 110,000 businesses.

Our experienced startup team can assist you with creating an

employee share scheme as well as raising capital and choosing
the right business structure that allows you to scale quickly
while protecting your business. If you have any questions about
your startup, get in touch with our lawyers today by calling
us on 1300 544 755.

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