Employee Share Option Plans for Australian Start-ups: Using the ESS Start-up Concession

Business Law: 28 July 2025

Author: Leisa Bayston - Our People

Employee share option plans (ESOPs) have become an increasingly popular tool for Australian start-ups to attract and retain talent while preserving cash flow. The introduction of the Employee Share Scheme (ESS) start-up concession has significantly enhanced the appeal of these arrangements, providing substantial tax benefits for both companies and employees.

This article explores how start-ups can leverage employee option plans under the ESS framework, examining the mechanics, requirements, and strategic advantages.

Understanding Employee Share Option Plans

Under an ESOP, employees receive options or rights over ordinary shares in their employer company.

For start-ups, option arrangements have become particularly common as they allow companies to offer equity-based compensation without immediate cash outlay. Unlike larger listed companies that often impose complex performance conditions, start-up option plans typically focus on simpler vesting conditions, primarily relating to ongoing employment and service periods.

The ESS Start-up Concession: A Game Changer

The ESS start-up concession, available for options granted on or after 1 July 2015, represents a significant tax advantage for eligible start-up companies and their employees. Under this concession, employees can reduce the assessable discount on granted options to nil, effectively eliminating upfront taxation on the benefit received.

Instead of paying income tax on the discount at grant, employees are assessed under the capital gains tax regime only when they eventually dispose of the shares acquired through exercising their options. This deferral can result in substantial tax savings, particularly when combined with the 50% capital gains tax discount available for assets held for more than 12 months.

Eligibility Requirements

To qualify for the start-up concession, both the company and the option arrangement must satisfy specific criteria:

Company Requirements:

· The company and its group entities must not be listed on any approved stock exchange

· The company must have been incorporated for less than ten years

· Aggregated turnover must not exceed AUD 50 million in the prior income year

· The employee's employer must be an Australian resident for tax purposes

Option Structure Requirements:

· The exercise price must be greater than or equal to the market value of ordinary shares at the time of grant

· Employees must hold options for a minimum period of three years (subject to limited exceptions)

· The arrangement must satisfy the basic ESS requirements, including the 10% shareholding limit

Vesting Conditions and Mechanics

Time-Based Vesting

Start-up option plans commonly incorporate time-based vesting conditions designed to encourage employee retention.

Typical structures include:

· Cliff vesting: Options vest entirely after a specified period (commonly 12 months)

· Graduated vesting: Options vest in tranches over time (e.g., 25% annually over four years)

· Milestone-based vesting: Vesting tied to company achievements or employment anniversaries

The vesting schedule serves dual purposes: it incentivizes long-term commitment from employees while ensuring the company retains talent during critical growth phases.

Performance Conditions

While less common in start-ups than in established companies, some option plans incorporate performance-based vesting conditions.

These might include:

· Achievement of revenue or profitability targets

· Successful completion of funding rounds

· Product development milestones

· Individual performance metrics

Acceleration Events

Many start-up option plans include provisions for accelerated vesting in specific circumstances:

· Change of control: Options may vest immediately upon acquisition or merger

· Involuntary termination: Protection for employees terminated without cause

· IPO events: Vesting acceleration upon public listing

Exercise Mechanics

The exercise of options typically involves:

· Notice period: Employees provide written notice of intent to exercise

· Payment: Settlement of the exercise price (if applicable)

· Share issuance: Company issues new shares or transfers existing shares

· Documentation: Updating share registers and issuing share certificates

Tax Timing Considerations

Under the start-up concession, the critical tax timing occurs at disposal rather than exercise. The ESS deferred taxing point typically arises when:

· Shares acquired on exercise can be freely disposed of (no genuine disposal restrictions)

· The employee actually disposes of the shares

· Fifteen years have elapsed since the original grant

Advantages for Companies

ESOPs allow start-ups to offer competitive compensation packages without immediate cash expenditure. This is particularly valuable during early-stage growth when cash resources are typically constrained and better deployed toward product development and market expansion.

Equity participation aligns employee interests with company success, creating powerful retention incentives. The potential for significant financial rewards through equity appreciation

can attract high-calibre talent who might otherwise be unaffordable through traditional salary arrangements.

Option plans provide flexibility to reward employees based on their contribution and seniority levels. Companies can tailor grant sizes and vesting schedules to different roles and recruitment needs without complex salary negotiations.

Successful implementation of employee option plans requires careful attention to several key factors:

· Legal Documentation: Comprehensive option agreements, employee share scheme rules, and corporate governance frameworks must be properly established and maintained.

· Valuation Methodology: Regular, defensible share valuations are essential for setting appropriate exercise prices and satisfying regulatory requirements.

· Communication and Education: Employees need clear understanding of their option rights, tax implications, and the potential value of their grants.

· Ongoing Administration: Effective systems for tracking grants, vesting schedules, exercises, and reporting obligations are crucial for compliance.

Advantages for Employees

The start-up concession offers substantial tax advantages to employee:

· No upfront tax: Elimination of income tax liability at grant

· Capital gains treatment: Favourable tax treatment on disposal

· CGT discount eligibility: Potential 50% discount for shares held over 12 months

· Timing control: Ability to manage the timing of taxable events

Employee options provide unlimited upside potential if the company succeeds. Early employees in successful start-ups can realize substantial wealth through equity appreciation, particularly if the company achieves significant growth or successful exit events.

Options create direct financial alignment between individual reward and company performance. This alignment can enhance job satisfaction and motivation, as employees directly benefit from their contributions to company growth.

Options ensure employees participate in the financial benefits of liquidity events such as acquisitions or IPOs, providing potential for significant financial returns that would not be available through salary alone.

Conclusion

ESOPs, particularly when structured to take advantage of the ESS start-up concession, represent a powerful tool for Australian start-ups to compete for talent while managing cash flow constraints. The combination of tax efficiency, alignment of interests, and wealth creation potential makes these arrangements attractive to both companies and employees.

Success depends on careful structuring to meet regulatory requirements, thoughtful design of vesting and exercise mechanics, and ongoing attention to administration and communication. When properly implemented, employee option plans can play a crucial role in building successful, high-growth start-up companies while rewarding the employees who contribute to that success.

For start-ups considering implementing employee option plans, professional advice on tax, legal, and valuation matters is essential to ensure compliance and optimize the benefits available under the ESS framework.

Please note that even where the criteria of ESS aren’t satisfied there are structures, for example utilising Loan – Funded Share Schemes which can still produce a tax effective result.

If you have any questions, please contact Aitken Partners’ experienced and friendly Business Law Team on (03) 8600 6000 to discuss your options.