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:
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 underChapter 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;
- to wholesale investors.
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.
This article was co-written by LUNA Startup Studio and Cake Equity
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.
For any questions please contact us at firstname.lastname@example.org.
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.
This article is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.