Employee share schemes: what founders need to know before setting one up
An employee share scheme is any arrangement where you give shares, or rights to acquire shares, to someone in connection with their work. Most employee share schemes in Australian start-ups are option plans rather than share issues. The employee gets a right to buy shares later at a price fixed today, and pays nothing unless they exercise. Two separate bodies of law apply, and founders routinely deal with one and forget the other.
How this usually starts
You told your first engineer she would get "about 2%". That was eleven months ago. She has just asked for the paperwork, your lead investor wants to see the option pool in the cap table before the term sheet goes out, and nobody has written anything down.
That is how most employee share schemes actually start. Not as a plan, but as a promise that now has to become a document.
The two rulebooks
The Corporations Act governs how you make the offer. Since 1 October 2022, Division 1A of Part 7.12 gives relief from the prospectus, licensing, hawking and advertising requirements if you meet its conditions. For an unlisted company those include stating on the face of the offer that it is made under Division 1A, leaving 14 days between the offer and the acquisition, keeping issues under 20% of issued capital across three years where money changes hands, and keeping each participant's cash outlay under $30,000 in any 12 month period.
Division 83A of the Income Tax Assessment Act 1997 does something different. It decides when your employee gets a tax bill and how big it is.
One note on "ESOP"
Plenty of founders search for "ESOP" because that is the term in the US content they have been reading. In the United States an ESOP is an Employee Stock Ownership Plan: a trust-based retirement structure, funded by the company and often used to buy out a departing owner. That is not what you are setting up. The Australian term is employee share scheme, and local use of "ESOP" is loose shorthand for an employee share option plan. The two structures do not map onto each other, so American templates and American tax commentary will steer you wrong.
If you want the ground-level version of how options work here before you read on, our guide to employee equity and ESOPs in Australia covers the mechanics.
When an employee share plan is worth doing
An employee share plan earns its keep when you are hiring people you cannot pay in cash. It makes a below-market salary credible, and it costs you nothing today.
Three signals that it is time:
• You are about to lose a hire on salary alone.
• You are raising, and the investor expects a pool sized and created before their money lands.
• Core work is being done by contractors. Division 83A reaches anyone providing services under an arrangement, so contractors can usually participate even though they are off payroll.
Employee share ownership works best when it is narrow and deliberate. A handful of people whose upside genuinely changes how they work, not a perk distributed broadly. And if you have no hires and no round, wait. A plan you do not use still costs you setup and annual ESS reporting.
How is an employee share scheme taxed in Australia?
The default position is unkind. Give someone shares below market value and the discount is assessable income in the year they receive it, whether or not there is any way to turn those shares into cash. That is the dry tax problem, and it is why plans get designed around the concessions rather than the other way around.
Section 83A-33 removes it. If your company is unlisted, every company in the group has been incorporated for less than 10 years, aggregated group turnover is $50 million or less, the employing company is an Australian resident, the participant holds the interest for three years, and the option's exercise price is at least market value at grant, there is no ESS taxing point at all. The gain is taxed under CGT when the shares are eventually sold. The ATO sets out the conditions for the start-up concession in full.
Miss one condition and you fall back to the ordinary rules, usually deferred taxation with a taxing point up to 15 years after acquisition. One piece of good news: since 1 July 2022, leaving your job is no longer a deferred taxing point, so a departing employee is not taxed on paper gains they cannot reach.
The condition founders trip on most is valuation. "Exercise price at least market value" needs a number you can defend, and the ATO publishes safe harbour valuation methods for exactly this situation. Guessing is not one of them.
Vesting, and what happens when someone leaves
Everyone knows about a one year cliff with monthly vesting after that. Fewer founders think through the rest: what happens to unvested options when someone resigns, what happens to vested ones, how long a leaver has to exercise, who decides whether a departure is good or bad, and whether vesting accelerates on a sale.
Those clauses are where the arguments happen. Get them wrong and a bad leaver keeps their upside while you carry the cost of it.
Dilution comes out of the founders
Founders think in issued shares. Investors think fully diluted, which means every option counts against you whether it has vested or not. A 10% pool is 10% off everyone on the register, and it is almost always created before an investor's money arrives, so it dilutes the founders rather than the incoming capital. Model it before you promise percentages, because "about 2%" of what is the entire question.
Our guide to raising capital in Australia covers the rest of what an investor will want settled before the money lands.
A change worth planning around
The start-up concession works by moving the gain out of income tax and into CGT. That has been worth a great deal, because a resident individual holding for more than 12 months got the 50% CGT discount.
That is changing. The Treasury Laws Amendment (Tax Reform No. 1) Act 2026 received royal assent on 26 June 2026. For resident individuals, trusts and partnerships, the 50% discount is replaced by cost base indexation plus a 30% minimum tax rate on gains accruing from 1 July 2027. Gains accruing before that date keep the discount, so anyone holding across it faces a split calculation. The four small business CGT concessions are unaffected.
The concession is still worth having. Deferring tax until there is actually a liquidity event is the main benefit, and that is intact. But if you are sizing a pool or drafting an offer letter now, the arithmetic you show your team should not assume a 50% discount will still be there when they sell.
Where to start
The letter to the employee is the last document you write, not the first. Before it you need plan rules covering vesting, leaver treatment, exercise mechanics and board discretions, a board resolution, a valuation you can stand behind, an updated cap table, and offer documents that fit inside Division 1A.
If you have already promised equity to someone, start there. Retrofitting a plan around a promise is harder than writing the plan first. It is still far easier than arguing about it after they resign. Our earlier piece on what founders need to get right with employee share schemes goes further into the design decisions behind those documents.
Common questions
Is an ESOP the same thing as an employee share scheme in Australia?
No. In the United States an ESOP is an Employee Stock Ownership Plan, a trust-based retirement structure funded by the company. In Australia the legal term is employee share scheme, and founders use "ESOP" as informal shorthand for an employee share option plan. Because the two structures are not equivalent, American templates and American tax commentary will give you the wrong answer.
When does an employee actually pay tax on options?
It depends on whether the plan qualifies for the start-up concession in section 83A-33. If it does, there is no ESS taxing point and the gain is taxed under CGT when the shares are sold. If it does not, the ordinary rules apply, usually deferred taxation with a taxing point up to 15 years after acquisition.
Can contractors take part in an employee share scheme?
Usually yes. Division 83A reaches anyone providing services under an arrangement, so a contractor doing core work can generally participate even though they are not on payroll. If contractors are doing work you would otherwise be hiring for, that is one of the signals a plan is worth setting up.
Does the option pool dilute my investors or me?
You, in almost every case. The pool is normally sized and created before an investor's money arrives, which means it comes off the existing register rather than off the incoming capital. Investors also count every option as issued whether it has vested or not, so the dilution is real from day one.
Should I set one up before I have hired anyone?
Not usually. A plan you are not using still carries setup cost and annual ESS reporting. The trigger is a hire you are about to lose on salary, an investor expecting a pool before their money lands, or core work being done by people you are not paying full rates.
Talk to us before the offer goes out
If you have already promised someone equity, the plan is easier to build now than it is to argue about later. Fixed fee, so you will know what your pool costs before you commit to it.
Book a free introductory call with us and we will tell you what the scheme needs and whether we are the right people to do it.