New Laws Reduce Red Tape for Operation of Employee Share Schemes
LUNA and Cake Equity break down these new employee share scheme (ESS) laws and explain why it’s the right time for you to revisit your ESS arrangements.
Equity can be a powerful tool in attracting, remunerating, incentivising and retaining top talent – this is especially the case for startups. In Australia, one of the ways to do this is by establishing an employee share scheme (ESS) which allows companies to offer key employees or service providers equity in the Company.
The current Australian regime that regulates the operation of ESS interests under the Corporations Act 2001 (Cth) (the Act) has traditionally been limited in flexibility and application. This has made it challenging for companies to unlock the full potential an ESS can provide. On 1 October 2022, changes to the Act in relation to ESS will come into effect to tackle this problem! With the aim to encourage growth amid young companies, these changes include (we’ll call these the New ESS Laws):
expanding the types of offers under an ESS which qualify for relief from a range of regulatory requirements; and
broadening regulatory relief for offers under an ESS that do not require payment to participate.
While the reforms generally reduce red tape to make the process easier for businesses to offer equity to eligible ESS participants, these new amendments will also hold private companies to a higher standard - ensuring participants are properly informed of their risk before acquiring any interest.
The time is now to revisit your ESS arrangements! You should get in touch with your advisors to see whether you’re maximising the opportunities that now come with the New ESS Laws.
A focus on Australian startups: ESS eligibility requirements for unlisted entities - what’s changed?
The strict regulations of the Act have traditionally made setting up and issuing ESS offers in Australia a tedious process - requiring companies to consider a range of topics, including disclosure requirements and exemptions, tax-advantaged option schemes and structures. . In many ways, the New ESS Laws will make it easier for unlisted entities to introduce share and options schemes within companies. By removing the ‘red tape’ on ESS, the new laws widen the eligibility criteria that must be met to qualify for relief in relation to an offer under an ESS and reduced the regulatory burden on unlisted companies, ultimately allowing them to compete with larger and listed companies for talent. They have also clearly defined the types of plans which will be subject to disclosure requirements – a topic that was a little grey up until now!
Below, we have highlighted the key changes:
1. Monetary Cap
Current: Offers under an ESS must not exceed $5,000 in value per 12-month period per participant.
New ESS Laws: Higher monetary cap ($30,000) for offers made to a participant per 12-month period, plus:
70% of any dividends; and
70% of any cash bonuses,
received in that year.
Key Takeaways:
A higher cap makes it easier for businesses to attract employees with improved and larger scale offers
The cap is ‘used up’ on expenditure (including where participants pay an amount on the exercise of options)
The cap does not apply where payment is required by a participant at time of an IPO or acquisition (ie. to allow the participant to purchase an unlimited amount)
The value of any unexercised options under an option plan from the previous 5 years can be accrued
2. Issue Cap
Current: ESS interests offered under an ESS must not exceed 20% of the company’s issued share capital
New ESS Laws: ESS interests offered under an ESS must not exceed 20% of the company’s issued share capital, but this can now be expanded by amending any governing documents
Key Takeaways:
The issue cap limits the proportion of shares that can be issued under an ESS to ensure the offer is genuinely to attract employees (and is not a pseudo-company raise)
The issue cap only applies where consideration under the ESS is involved
If you’d like to exceed the 20% cap, this can now be done – if you update your Constitution to cater for it. But you should consider what allocation to give to your option ‘pool’, and the impacts of the size of that pool on future ownership and investment.
3. Trusts
Current: Trustees managing employee share schemes can obtain relief if the trust deed meets certain requirement.
New ESS Laws: Trustees managing employee share schemes can obtain relief if the trust deed meets certain requirement.
Key Takeaways:
Trustee holds interests on behalf of participants and must act in their best interests
4. Contribution Plans
Current: ESS must not involve a contribution plan
New ESS Laws: ESS with an associated contribution plan can obtain relief if the contribution plan meets certain requirements
Key Takeaways:
Contribution plans allow participants to make payments (or deduct amounts from their wages) to acquire an ESS interest over time
Money paid into a contribution plan does not ‘use up’ the monetary cap
4. Loans
Current: ESS must not involve a loan to a participant to acquire an ESS interest
New ESS Laws: ESS with an associated loan can obtain relief if the loan meets certain requirements
Key Takeaways:
A loan allows a participant to take full ownership of their interest immediately
The loan must have no interest or fees payable
For unlisted companies, a loan cannot be provided to existing shareholders
5. Disclosure
Current: Offers under an ESS must be accompanied with certain disclosure documents (annual report, director’s solvency resolution and valuation resolution), unless a specific exemption applies
New ESS Laws: Businesses are held to higher disclosure standards by the following new requirements, but only where ESS offers require payment by participants (e.g. payment of an exercise price for options):
offer document must contain certain set of warnings
certain financial information must be provided about the entity making the offer (e.g. financial reports or profit and loss statement)
valuation of interests being offered is provided
statement is given that the body is solvent
additional disclosure documents in relation to a loan, contribution plan or interests held by trustees (as applicable) is provided.
If you’re offering ESS for no consideration (completely free shares or zero exercise price options, for example), these requirements are effectively dispensed with.
Key Takeaways:
Different disclosure documents are required depending on the nature of the ESS interest
Disclosure may be required upfront and where payment is required at a future stage
Offers that do not require payment (upfront nor at any future stage) do not require disclosure to be eligible for regulatory relief
Mandated 14-day waiting before between disclosure and acceptance by a participant is required to allow sufficient time to consider their decision
Participants can request copy of full version of documents (if a summary of terms is only given)
Tax implications should be considered if you offer free shares or free options with zero exercise price
Modifications to existing disclosure requirements
While entities that operate an eligible ESS are exempt from the same disclosure requirements which apply generally to financial services providers, a different set of streamlined disclosure requirements are still needed to ensure participants are making informed decisions.
For unlisted entities, the new reforms will ensure that businesses are properly informing participants about the risks of acquiring any ESS interest – especially because the underlying value of ESS interests in private entities are difficult to ascertain.
The new reforms also provide further relief by removing any disclosure requirements for an eligible ESS that does not require payment to participate.
The takeaway from above is that at least 14 days before the option becomes exercisable or the incentive right vests, unless one of the existing exemptions can be applied to an offer, the company must provide each participant with the following documents:
information to support a valuation of the ESS interest;
Company financial statements; and
a solvency statement.
Companies are also required to provide the above information within 30 days after a request for the information has been made by a participant before the options expire.
But what are the existing exemptions?
The exemptions under Chapter 6D of the Act will continue to apply (for now). This means that unless an exemption applies, offers of securities must be made under a disclosure document.
These exemptions include making offers under one of the following rules:
small scale offerings (that is offers made to 20 individuals in 12 month period);
to sophisticated and professional investors;
to senior managers and other people associated with them(e.g. their spouse and close relatives), or a body corporate controlled by them;
So what does this mean for you?
The New ESS Laws are a welcome change, and are expected to provide greater flexibility for startups to offer equity packages to employees and staff. The improved and ‘streamlined’ legal requirements will give start-ups that extra push in finding talented individuals who will help their companies take off and thrive!
Now is the time to get in touch with your advisors to see what these new ESS laws mean for you.
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This article was co-authored by LUNA Startup Studio and Alex Kazovsky from Cake Equity.
Got questions? Email the LUNA legal team.
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About LUNA Startup Studio
A full-service startup studio, LUNA consolidates its legal, accounting and education design expertise to support fast-growing startups and scale-ups, providing consistent cross-functional support to critical foundations of businesses as they scale. LUNA’s uniquely cultivated network opens up invaluable parts of the startup ecosystem, including investors and corporate venture arms, and supports entrepreneurs in launching, securing investment, scaling, and beyond.
About Cake Equity
Cake is one of Australia's most exciting technology companies around! Cake provides companies with a frictionless platform that allows them to offer employee ownership at the click of a button. Our aim is to empower start-ups and scale-ups globally to create a better world through fast and simple equity, and developing teams with an 'owner mindsets'. A better future is being created by great teams innovating and building awesome companies with inspired teams of 'owners'. Being able to manage your equity in one cloud-based solution has never been easier. So sign up now and invite and motivate your team with real value, in real time.
