Keeping Your Options Open - Employee Share Schemes for Startup Founders

Employee Share
Option Plans
Jill McKnight, Practice Leader (Corporate)
September 2019

2 Transforming Legal Services
Contents
What is an Employee Share Option Plan?
2 What Documents are Involved?
3 How are Options Valued?
4 How do Options Vest?
5 How Options are Exercised?
6 What Happens to Options if an Employee Leaves?
7 What Happens to Options if there is an Exit?
8 Q&A
1

What is an Employee Share Option Plan?

Employee Share Option Plan
• An incentive scheme for employees and contractors
• The company grants the employee or contractor a right to
acquire shares in the company subject to certain conditions
• 1 option = 1 share
• Difference between share plans and option plans

ATO ESOP Scheme
On 1 July 2015, new tax laws introduced for eligible startup ESOPs.
If eligibility criteria are met, startups can issue their employees with
options tax efficiently.
• Tax only payable on the sale of the options or shares (or 15 years after
the date of issue, if earlier).
• The employee may be eligible for a CGT discount if it has owned the
options for over 12 months.
These changes helped startups integrate ESOPs into their employment
remuneration structure.

Extracted from the amazing new ESOP Guide!

What Documents are Involved?

ESOP Documents
Offer Letter
This is a participant’s personal offer of options. It contains:
1. The number of options being granted
2. The exercise price of each option
3. The vesting conditions
Plan Rules
These are the terms and conditions that apply to the ESOP.
They are the same for all participants.
Approvals
Approval is necessary to implement the ESOP and issue options
under the ESOP. e.g Shareholders and/or Board resolutions.

How are Options Valued?

Exercise Price
• Each option is given an exercise price.
• It is the price payable when the option is ‘exercised’
(converted into shares).
• The participant doesn’t have to pay anything when they
receive their options.
• The exercise price is calculated based on the market value of
the option at the time the option is granted NOT when it is
exercised.

Market Value
• If the company is eligible at the time the options are granted,
the market value can be calculated based on the ‘net
tangible assets’ of the business. This can be great in the
startup context. Otherwise, it is the standard market value.
• Generally, participants will wait for an exit event to exercise
their options (so they know whether or not it is worth paying
the exercise price).

Net Tangible Assets Test – eligibility criteria
• Eligible startup?
• Do you anticipate a change in control in the next 6 months?
• Have you raised more than $10m in the last 12 months?
• Is the company less than 7 years old or a small business
entity (aggregated turnover of less than $10m)?
• Will you prepare a financial report for the year that complies
with Corporations Act accounting standards?

How do Options Vest?

• Options are generally granted on the condition that they need to be
earned.
• Options are earned through vesting.
• Most commonly options vest based on time.
For example, a 4 year vesting period with 1 year cliff.
• Options can also vest at certain performance milestones.
• Unvested options generally lapse when an employee leaves.
• Options that have vested are the employees and they will receive
the benefit of these if they leave or the company is sold.
Options are
granted
Options vest
Options are
theirs

Year 1
25% of the options vest
at the end of year 1
They now start vesting
monthly/quarterly/yearly
50% of the options have
vested
If a participant leaves part
way through year 4 –
they’ll benefit from the
options that have vested
up to that point
Options are
granted
No further vesting –
participant has earned
all their options
Year 2 Year 3 Year 4 Beyond
If a participant was to leave
now, they lose all their
options
4 year vesting with 1 year cliff

How are Options Exercised?

Exercising Options
Options can be exercised during the Exercise Period (after the options
have vested but before they lapse) or at an Exit Event – depending on the
Plan Rules
Most commonly, options are exercised at an exit event so that the
participant can determine whether the value has increased and
whether they want to pay the exercise price.
To exercise an option, the participant needs to give the company a
signed exercise notice and pay the exercise price of those options.
The company will issue the shares.
The participant can sell their shares (subject to the Shareholders
Agreement).

What Happens to Options if an
Employee Leaves?

Leaving the Company
• Leaver = someone who stops working for the company.
• The Board is given discretion to decide what happens when a
participant is a leaver.
• Unvested options generally lapse.
• Vested options can be:
(i) sold at their fair market value; or
(ii) retained.

What Happens to Options
if there is an Exit?

Exit Event
• Exit Event = (i) IPO; (ii) share sale; or (iii) business sale.
• The Board is given discretion to decide what happens at an exit event.
• Unvested options are either:
(i) cancelled;
(ii) bought back for their fair market value; or
(iii) have their vesting accelerated.
• Vested options can be:
(i) bought back for their fair market value; or
(ii) exercised.
• If options are exercised, the employee will participate as an ordinary
shareholder in the sale.

Case study: Lumachain
Revel is the Head of People and Culture at Lumachain.
Lumachain’s ESOP program has helped attract and retain world class talent.

Value and Engagement of an ESOP
Mark Saliba
General Manager, Business Development
September 2019

Advantages of an ESOP
Employee retention Tax advantages
Recruit the best talent into your business
Cash flow advantage – options used in
lieu of salary increases
Operate as a means of starting a saving
plan for the employee
Ownership mentality/culture – increased
productivity

Employee Equity Plan Engagement
Clients managing their Employee Plan internally on a spreadsheet
Employee receives an offer and doesn’t hear anything for 3 years
Employee has no easy access to information
Out of sight, out of mind
How does the employee know what they are doing is contributing to the company growth and ultimately
their share growth?
Value of the Equity issued to employees may be $1,000,000, if you do not have any engagement
strategies in place its like spending $1,000,000 on a commercial to only have it played at 2:00am
when no one sees it.

Employee Engagement Strategies
Online
Portals
Mobile
App
Simplified
Communications
Videos QR Codes Online
Education
Surveys

Keeping Your Options Open - Employee Share Schemes for Startup Founders

Keeping Your Options Open - Employee Share Schemes for Startup Founders

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