Poor drafting of legislation intended to support widespread use of equity by unlisted companies instead prevented most from developing a compelling ESOP. Complete with a decision tree, this Insight will help you determine whether now is the right time to consider a new ESOP or even a replacement.

GRG Remuneration Insight 140

by Denis Godfrey, James Bourchier & Peter Godfrey
22 June 2022

From 1 October 2022 unlisted Companies can, for the first time, consider using equity plans (or Employee Share Ownership Plans (ESOPs)) extensively as part of rewarding employees. Previously, poor drafting of legislation that was intended to support widespread use of equity by unlisted companies resulted in bear-traps and impractical limits that prevented most unlisted companies developing a compelling ESOP. Now, the Tax Act and Corporations Act will work together to create new opportunities. If your business is unlisted and has had an equity plan, or you have wondered whether an equity plan might be right for your company and your staff, now is the time to revisit the question of which equity plan might be right for you. Even if you do not want to have real shares being transferred to employees, “phantom” or “simulated” plans previously considered derivatives will soon be allowed to be used by unlisted companies. This Insight provides you with everything you need to know to decide whether now is the right time to consider a new or even a replacement ESOP (or skip to the decision tree on the last page if you prefer).

Note: the information contained in this Insight is general in nature and is not tax or financial advice.

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The Key Questions to Ask

What is the primary purpose of an equity plan or ESOP for your business?

Understanding the key objectives behind the desire for a real or simulated equity plan for your business will determine the available design pathways:

  1. If the primary purpose is to provide employees with an interest in the business without transferring ownership, “phantom” or “simulated” plans should be used, which do not involve any real shares ever being transferred (previously this approach was limited due to being classified as derivatives in many cases). The main reasons that many unlisted businesses do not want to transfer ownership of shares include:
    1. Shareholder agreements are complex: they can be, but with the right advice it can be a streamlined process. Our team can help you develop a shareholder agreement that protects original owners by including a sale requirement upon cessation of employment.
    2. Ex-employees remain shareholders: this can be solved by having a compulsory buy-back by other shareholders and/or the business in the case of cessation of employment.
    3. Employee shareholders get to vote: B-class shares can be used that remove voting and/or dividend entitlements.
    4. Employees will want full shares to get dividends: Rights can be designed to include a “dividend equivalent” that ensures dividends do not unfairly disadvantage right holders.
  2. If the primary purpose is to provide employees with an interest in the business and to also transfer ownership, then plans that involve genuine equity should be considered.

If the answer to the primary purpose question is about attraction, retention, alignment or motivation/incentives, and you are not sure about, but also not opposed to transferring some ownership, then the questions that follow will become the key variable for you. However, unless you are open to the idea of transferring some ownership, it is likely that a phantom or simulated plan is the best solution for you.

Do you want to share current value, or future value only?

Whether you want to create certainty and reward participants by sharing current value, or only share future value, will lead you down different design pathways:

  1. If the primary purpose is to provide selected employees with a share of the future growth of the business, options or Share Appreciation Rights (SARs) should be considered (with an exercise price).
  2. If the primary purpose is to provide a share of the existing business, perhaps to reward loyalty, past contributions or perhaps only if certain conditions are met in the future, as well as future growth, then Rights should be considered (no exercise price).

How will you solve for the lack of a ready market for Shares in your business?

The key hurdle for unlisted equity plans relates to the lack of a ready market for the equity involved, which is necessary to a) ensure the benefit can be turned into cash at some point and b) that tax can be paid when it falls due. If these problems are not addressed then what you are offering may be an empty promise at best, or a tax liability that could lead to bankruptcy of employees at worst. Common solutions include:

  1. Clear liquidity event expectation: if there is a clear expectation that an IPO or trade sale will occur before the taxing point arises, then genuine equity is likely to be best for you, because it involves the lowest cost and lowest cash-flow impact.
  2. Buy-back agreement: if the plan is designed to be self-funding, or the business has plenty of free cash-flow, then the business can use real equity (ordinary shares or non-voting, non-dividend entitled B-class shares), and guarantee that shares will be bought-back by the business when participants want to sell.
  3. Simulated or phantom equity plans can be used to simulate or replicate equity ownership, but will only ever involve cash payments, and no real equity is involved. Budgeting for cash-awards (usually under a self-funding model) solves the lack of market problem.

Does your business qualify for the start-up concessions?

A special instrument in the Tax Act allows for up-front tax to be reduced to nil, and for CGT treatment to apply to any eventual sale of shares (or otherwise no tax applies if no sale ever occurs). This is great for companies that meet the conditions, especially if it is not clear whether a liquidity event may arise, because no tax bill will arise in this case. The main qualifying questions include (at a high level) whether:

  1. Your business has a history of fewer than 10 years (including any acquired entity or parent entity)
  2. Your business has turnover of less than $50m for the last financial year

If you answer yes to these questions, it is likely the start-up plan is the best plan for you. However, in most cases it involves the use of options with a genuine exercise price, which means that additional disclosure requirements and $30,000 limits (per employee per year, in broad terms) will apply.

Key Regulatory Points to Note – Legal and Tax Matters

Key aspects to note about the new Corporations Act provisions

  1. Offers that do not involve payments by participants are not subject to limits and involve minimal compliance. This should improve the ability of companies to offer:
    1. long term variable remuneration equity grants,
    2. equity grants that are compulsory parts of fixed pay or deferred short term variable remuneration, or
    3. equity grants to employees as an additional benefit.
  2. Offers of equity by unlisted companies that involve payment by participants (salary sacrifice, purchase, or genuine exercise prices) are subject to limits and significant compliance requirements, including a $30,000 per employee per year limit (with some limited variation). However, modern “Share Appreciation Rights” create a structure that is identical to an option, and results in the employee foregoing the number of shares that is equivalent to the exercise price (typically the value of a Share at the time the SAR is issued, which is a way of simulating a contribution without a contribution being made that would trigger the limits applying).
  3. The 12 months on-sale relief applicable to securities issued without a disclosure document that was included in Class Orders 14/1000 (listed companies) and 14/1001 (unlisted companies) has not been replicated in the new ESS provisions of the Corporations Act. ASIC has indicated to us that they do not intend to replicate the previous relief.
  4. For employees who are classifiable as “senior managers” the $30,000 limits applicable to option and contribution plans can be overcome by relying on “Section 708” relief instead, which may restore the attractiveness of the ”start-up plan” in cases where the $30,000 limit would otherwise be problematic.
  5. See GRG Insight 139 for full details of the Corporations Act changes.

Key aspects to note about the current iteration of the Tax Act

  1. Deferred Employee Share Scheme (ESS) tax is generally the best tax treatment available, with start-up plan concessions being the most favourable, which involve an immediate reduction, and deferral, with ESS deferral alone being the next most favourable (the most common approach/outcome). This is because ESS deferral is equivalent to a 100% CGT discount compared to paying tax up-front and getting concessional CGT tax treatment on any growth. Refer to GRG Insight 133.
  2. Shares generally cannot be used unless strict conditions are met (including making offers to at least 75% of staff with 3 or more years of service). For this reason, it is rare for Shares to be offered in unlisted companies.
  3. The Start-up plan is generally the best plan for companies with <$50m turnover and <10 years of history, because no tax will apply until and only if Shares are ultimately sold (however the instrument must generally involve a genuine exercise price, in which case the $30,000 limit per employee per year applies).
  4. Share purchase loan plans are generally not recommended because they are the highest cost to the company due to a loss of tax deductions, the highest risk to participants because of the optional structure, and they can only be used once per employee due to restrictions in the Tax Act. See Insight 124 for a full explanation of why Rights are generally superior.
  5. From 1 July 2022, tax on equity held at termination will not apply, which removes a major problem.


After 1 October 2022 is the best time for unlisted companies at all stages of development to think about rolling out an equity plan or ESOP to employees, whether it is simulated or based on real equity. These plans can support your business to attract and retain key talent, align key staff with the interests of the business, preserve cash, support succession, provide you with an exit pathway or give employees the “skin in the game” that research shows lead to improved engagement and long term company performance. If you think one of the types of plans we outlined in this Insight might be for you, contact us for a no-obligations discussion. Even if you have an existing equity plan, it is unlikely to remain the optimal plan for you. Our consultants are among the most experienced equity plan consultants in Australia and can tailor a solution to your circumstances.

Decision Tree

See the decision tree below for graphical guidance on how to make a choice about what kind of equity plan might be right for your business.

Unlisted company ESOP type decision tree

Note: this decision tree does note address plans by which employees may sacrifice cash or bonuses to acquire equity, which is possible but is subject to additional requirements.

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