Setting Up an Employee Share Option Plan (ESOP) the Right Way in Australia

An Employee Share Option Plan (ESOP) — more precisely called an Employee Share Scheme (ESS) under Australian law — is a programme under which a company offers employees (and, since the 2022 reforms, contractors and service providers) the right to acquire shares or options over shares in the company. When structured correctly, an ESOP lets you compensate and retain talented people with equity upside at a time when your cash is constrained, aligning their long-term incentives with yours.

For Australian startups, the ESOP is not just a nice-to-have benefit — it is a critical competitive tool. The best engineers, product managers, and early commercial hires in Australia are choosing between well-funded startups, large tech companies, and US-backed firms. A well-structured ESOP, with genuine upside potential and favourable tax treatment, is often the deciding factor in those hires. Without an ESOP, you will lose talented people to competitors who have one.

The good news is that Australia's Employee Share Scheme framework — overhauled by the 2022 reforms and supported by the ATO's startup concession — is now genuinely founder-friendly. This guide explains how to take advantage of it.

The Australian ESOP framework has two main pillars:

• Tax law: The Income Tax Assessment Act 1997 (Division 83A) governs when employees are taxed on ESS interests. The key principle is that employees may be taxed either at grant, at vesting, or (under the startup concession) only at the time of sale. The ATO administers this framework, and the rules were significantly improved by changes effective 1 July 2022.
• Corporate law: The Corporations Act 2001 governs what disclosures a company must make when offering ESS interests to employees. A major overhaul took effect on 1 October 2022, removing the old $5,000 cap and introducing a streamlined disclosure framework for unlisted companies.

Both pillars changed significantly in 2022, making the regime substantially more useful for Australian startups. The sections below explain what changed and how to use the new rules to your advantage.

The Treasury Laws Amendment (2021 Measures No. 7) Act 2022 introduced Division 1A of Part 7.12 of the Corporations Act, which took effect on 1 October 2022. This was the most significant overhaul of the corporate law ESS framework in many years. Key changes, as analysed by Johnson Winter Slattery and Ashurst, include:

1. Removal of the $5,000 cap: Under the old Class Order 14/1001, ESS offers to employees of unlisted companies required each participant to receive no more than $5,000 worth of interests in the prior 12 months to access simplified disclosure relief. This cap was removed entirely. Founders can now grant much larger option allocations without triggering the old disclosure burden.
2. Broader participation: The new regime broadens participation beyond employees and directors to include all contractors and service providers of the entity — important for startups that rely heavily on contractors in the early stages.
3. Streamlined disclosure for unlisted companies: Instead of a full prospectus, unlisted companies offering options or incentive rights are required to provide a specified offer document with streamlined information: terms of the offer, general risk information, a solvency statement, valuation of interests, and financial statements. For options with no upfront payment, disclosure is required at both grant and exercise stages.
4. Default 20% issue cap: Unlisted companies may specify their own issue cap in their constitution. Where no cap is specified, the default is that total offers in a 3-year rolling period must not result in underlying securities exceeding 20% of fully paid shares.
5. No ASIC notification required: Companies relying on the new Division 1A no longer need to notify ASIC of their reliance on regulatory relief — reducing administrative overhead.
6. Monetary cap for paid interests: Participants in unlisted entity schemes requiring payment may outlay up to $30,000 per 12-month period, with unused capacity carrying forward for up to 4 additional years (maximum $150,000 cumulative).

ASIC also published ASIC Corporations (Employee Share Schemes) Instrument 2022/1021 to clarify the new regime and provide additional relief, including for foreign companies operating through Australian subsidiaries, as noted by Minter Ellison.

Separate from the Corporations Act changes, the ATO introduced significant tax improvements effective 1 July 2022, as set out on the ATO's key ESS changes page. The most important change for startups is:

• Employment ceasing is no longer a deferred taxing point (from 1 July 2022). Under the old rules, when an employee left the company, their deferred ESS interests became immediately taxable — even if the employee could not easily sell the shares to pay the tax. This was a major deterrent to startup ESOPs, because it meant departing employees faced a cash tax bill on illiquid shares. This change removes that barrier entirely. Employees who leave before vesting no longer face an immediate tax bill on unvested interests.
• Maximum deferral period extended to 15 years (previously 7 years in some cases).
• Significant ownership test eased: All equity interests (including rights) are now counted toward the 10% ownership threshold (increased from 5% pre-July 2015).
• Tax refund available if an employee acquires rights and later chooses not to exercise them or allows them to be cancelled (subject to conditions).

The startup tax concession is the most favourable ESS tax treatment available to Australian startup employees. When it applies, there is:

• No tax at grant — the employee pays nothing when options are granted.
• No tax at vesting or exercise — the employee pays nothing when options vest or when they exercise (convert options into shares).
• Tax only when the employee makes a capital gain at sale — on an IPO, acquisition, or secondary sale.
• 50% CGT discount applies from the date options are granted (not from the date shares are acquired on exercise), provided the holding period requirement is met — a significant benefit for long-tenured employees.

This framework, set out by the ATO and explained in detail by Cake Equity, makes Australian startup options genuinely attractive. Employees who join early and hold options through to a liquidity event pay tax only on the gain, at the discounted CGT rate, rather than facing income tax at grant or vesting.

The startup concession is not available to all companies or all employees. The following criteria must all be met, according to the ATO and LegalVision:

Important for founders: Because founders typically own more than 10% of their company, they generally cannot access the startup concession for their own ESS interests. The concession is designed for employee equity grants, not founder equity. Founders should seek independent tax advice on structuring their own equity.

The ATO has also published approved market valuation methods for unlisted startup shares, including a net tangible assets safe harbour, for companies that have not raised more than $10 million in capital in the prior 12 months. The ATO has also published model option plan documents and standard offer letters to help startups establish an ESS under the startup concession framework.

Most Australian startup ESOPs grant options (also called rights) rather than shares directly. Here is why, and when each is appropriate:

Options are preferred for most startup ESOPs because: (1) they do not require the employee to pay anything upfront; (2) they do not dilute the cap table until exercise; and (3) they are simpler to manage at scale across a growing team. Sources: Cake Equity; LegalVision.

Under the startup concession, the exercise price of options must be set at no less than the market value of an ordinary share at the date of grant. Setting the exercise price below market value disqualifies the grant from the startup concession — meaning the employee faces income tax at vesting rather than CGT at sale.

For very early-stage companies with no external capital raised, market value may be close to nil (the ATO's net tangible assets method may apply). Once you have raised external funding at a known valuation, market value is more clearly established. The ATO has published approved valuation methods to help startups set a defensible exercise price. This is also important for the ESIC connection: if your company qualifies as an ESIC, the share value and option pricing should be documented consistently across instruments.

In practice, most founders set the exercise price at the last funding round price (or the ATO-approved valuation), grant options to new hires with an exercise price set at the current market value at the time of their grant, and reset the exercise price each time a new priced round establishes a new market value. Keep a valuation record at each grant date.

The most common vesting schedule for Australian startup option plans is a 4-year vest with a 1-year cliff. Here is how it works:

• Year 1 (the cliff): No options vest in the first 12 months. If the employee leaves before their 12-month anniversary, they receive no options.
• At 12 months: 25% of the total grant vests immediately (the cliff vest).
• Months 13–48: The remaining 75% vests monthly or quarterly in equal instalments over the following 36 months.

So for a grant of 100,000 options: 25,000 vest at month 12; then approximately 2,083 vest per month for months 13–48; all 100,000 are fully vested at month 48.

This structure is described as standard practice by leading Australian startup lawyers and equity management platforms including Cake Equity and LegalVision. The cliff protects you from having to give equity to someone who joins and leaves within the first year. The monthly or quarterly vest thereafter rewards ongoing contribution. Note that the 4-year/1-year cliff is market convention, not a legal requirement — you can adjust the schedule, but deviating significantly from this norm may make your ESOP less competitive.

The most commonly cited option pool range for Australian startups is 10–15% of fully diluted share capital, with 10% being the most frequent choice at seed stage according to HSBC Innovation Banking's 2026 Term Sheet Guide. Pools typically grow with each funding round as the team expands.

Key considerations when sizing and timing your option pool:

• Set up your pool before a priced funding round. Investors typically require an option pool to be in place (or created) as part of a priced round. If the pool is created before the round closes (pre-money), founders bear the full dilution from the pool. If it is created post-money, investors share in the dilution. Negotiating whether the pool is pre- or post-money is one of the most important points in a term sheet — the difference in founder dilution can be several percentage points.
• Size for your 18–24 month hiring plan. Model how many key hires you need in the next two years and what option grants they would expect (see below), then work backwards to confirm the pool size is sufficient. An undersized pool means you will need to top it up (diluting all shareholders) sooner than expected.
• Typical grant sizes by seniority (these are general practitioner benchmarks, not regulated requirements): VP/Head of Function: 0.25–0.75%; Senior Engineer/Product: 0.05–0.25%; Early-stage employee (pre-product-market fit): 0.1–1.0%+. Amounts vary significantly by stage, company valuation, and individual negotiation.

Employers who offer shares, rights, or options to employees under an ESS have two mandatory annual reporting obligations under Australian tax law. Both deadlines fall shortly after the end of each financial year (30 June), as set out by the ATO:

Companies with 50 or more ESS participants must lodge electronically. Employers must retain employee statement information for a minimum of 5 years. These deadlines are confirmed by Andersen Australia.

A taxing point occurs when vesting conditions are met, when disposal restrictions lift, or (post-1 July 2022 reform) when 15 years have passed since grant. Reporting is required even if the company is overseas, provided employees are Australian-based or worked in Australia during the vesting period.

ATO reporting under the startup concession: For options granted under the startup concession, there are no taxing points at grant, vesting, or exercise — so employees generally have no annual ATO reporting obligation for those interests. However, the company is still required to lodge an ESS annual report with the ATO in the year the options are granted, as noted by Cake Equity. This is a reduced but non-zero administrative burden.

ASIC obligations post-1 October 2022: Under the old Class Orders (CO 14/1000 and CO 14/1001), companies were required to notify ASIC of their reliance on regulatory relief. This requirement has been removed under the new Division 1A, as confirmed by Johnson Winter Slattery. However, unlisted companies must still prepare compliant offer documents and financial statements for each ESS offer under the new disclosure framework. For options with no upfront payment, disclosure is required at both grant and exercise stages.

Record-keeping tip: Build your ESS administration into your equity management platform (Cake Equity, Carta, or similar) from the start. These platforms typically automate the generation of ATO-compliant ESS statements and annual reports, significantly reducing the compliance burden as your option pool grows and your team scales.

Follow this checklist to establish a compliant, investor-ready ESOP:

• ☐ Confirm startup concession eligibility: Verify your company: (a) is unlisted; (b) was incorporated within the last 10 years; (c) has aggregated turnover ≤ $50 million; (d) is an Australian resident company. Do this before drafting any option plan.
• ☐ Engage an Australian startup lawyer: Have a startup-specialist lawyer draft your option plan rules, board resolutions, and offer letters. Use a lawyer familiar with Division 1A of the Corporations Act and Div. 83A of the ITAA 1997. Cost: typically $3,000–$8,000 for a standard ESOP setup.
• ☐ Set up an equity management platform: Implement Cake Equity, Carta, or Ledgy to manage your option pool, track grants, generate offer documents, and automate ATO reporting. Do this before your first grant.
• ☐ Establish your option pool in your constitution: Determine your pool size (typically 10–15% fully diluted), amend your company constitution if needed to set your issue cap, and pass the necessary board and shareholder resolutions.
• ☐ Get a market valuation for exercise price setting: Use the ATO's approved valuation method (or the NTA safe harbour for very early-stage companies) to set a defensible exercise price. Document the valuation at each new grant date.
• ☐ Prepare compliant offer documents: Under Division 1A, you must provide each participant with a compliant offer document before they accept. Do not issue options via an email alone.
• ☐ Review your vesting schedule: Standard is 4-year vest with 1-year cliff. Decide on monthly or quarterly vesting for the post-cliff period. Consider accelerated vesting provisions for acquisition scenarios (single-trigger vs. double-trigger).
• ☐ Decide on the post-departure exercise window: Most plans allow 90 days post-departure to exercise vested options. Consider whether this is appropriate for your situation and document it clearly in the plan rules.
• ☐ Calendar your ATO deadlines: Note 14 July (employee statements) and 14 August (ATO annual report) in your company calendar immediately. Missing these is an avoidable compliance failure.
• ☐ Communicate the plan to employees clearly: Provide plain-language explanations of the option plan to each employee — what their options are worth, how vesting works, and what triggers a tax event. Employees who do not understand their equity are not retained by it.
• ☐ Review the pool before each funding round: Before closing any priced equity round, review the option pool size with your lead investor. Negotiate whether any top-up is pre-money or post-money in your term sheet.

Yes. The October 2022 Corporations Act reforms explicitly broadened ESS participation to include all contractors and service providers of the entity — not just employees and directors. This is a significant change that makes it possible to incentivise key contractors, advisers, and service providers with equity. The tax treatment under the startup concession may differ depending on whether the contractor is engaged as an individual versus through a corporate vehicle, so seek specific tax advice for non-employee participants before making grants.

It depends entirely on what your option plan rules say. There is no automatic acceleration of unvested options under Australian law — the plan document governs. Most plans include some form of change of control provision, which may be:

• Single-trigger acceleration: Unvested options vest automatically on acquisition of the company.
• Double-trigger acceleration: Unvested options only accelerate if the employee is also terminated (without cause) within a defined period after the acquisition.

Institutional investors often prefer double-trigger acceleration to preserve employee retention through the acquisition integration. You should decide your approach before making any grants and document it clearly in the plan rules, as it will affect both employee expectations and acquirer negotiations.

Yes, and the timing benefit is valuable. Under the startup concession, the 50% CGT discount clock starts from the date the options were granted — not from the date the employee exercises and acquires shares. This means an employee who was granted options 2 years ago and exercises today has already accumulated 2 years toward the 12-month CGT discount holding period requirement. In practice, for employees who hold their options for the full vesting period (typically 4 years) before exercising and selling, the CGT discount is essentially guaranteed. This is a meaningful tax advantage compared to structures where CGT accrues from the exercise date. See the ATO's key ESS changes page for the authoritative position.

Yes — in fact, most ESOPs are set up after the company has raised its first external round, because that is when (a) the company has a defensible market valuation for setting exercise prices, and (b) the startup has the traction and budget to attract the hires that benefit most from equity incentives. The exercise price must be set at no less than the market value of an ordinary share at the date of grant, using an ATO-approved valuation method. For most seed-stage companies, the exercise price will be set equal to the price per share of the most recent priced round. The key constraint is that the company must still meet the startup concession criteria (unlisted, <10 years old, aggregated turnover ≤ $50M) — which most seed-stage companies easily satisfy. The ATO's startup concession is designed for exactly this stage: post-incorporation, post-first-raise, but pre-IPO.

Under the post-October 2022 Corporations Act framework, if your company constitution does not specify a different issue cap, the default rule is that options issued under the ESOP must not result in the total underlying shares exceeding 20% of the company's fully paid shares over any 3-year rolling period. For most startups at seed stage with a 10–15% option pool, this is comfortably within the default cap. If your pool is larger or you have historically issued significant options, check the cumulative 3-year total. You can also specify a different (higher or lower) cap explicitly in your constitution — which is good practice to avoid ambiguity. This cap applies to all ESS offers collectively, not just one employee's grant.

Here is a step-by-step example using the ATO's ESS startup concession (s.83A-33, ITAA 1997).

Scenario: An employee is granted 50,000 options at a $1.00 exercise price (equal to share fair market value at grant, satisfying the startup concession requirement). The company exits at $10.00 per share four years later.

Step 1 — Gross gain

Gross gain = ($10.00 − $1.00) × 50,000 = $450,000

Step 2 — No income tax at grant or exercise

Under the startup concession, there is no income tax event at grant and no income tax event at exercise. The employee pays only the $1.00 exercise price per option. Cost base for CGT = $1.00 × 50,000 = $50,000.

Step 3 — 50% CGT discount applies

The startup concession deems the 12-month CGT holding clock to start from the date of grant (not exercise). Since the employee held for >12 months from grant, the 50% CGT discount applies:

Capital gain = $500,000 − $50,000 = $450,000
Taxable gain = $450,000 × 50% = $225,000

Step 4 — Effective tax rate

Tax @ 47% marginal = $225,000 × 47% = $105,750
Effective rate on $450,000 gain = $105,750 ÷ $450,000 = ~23.5%

Comparison: Without the startup concession (standard ESS deferral), the full $450,000 gain would be taxed as ordinary income at up to 47%, resulting in approximately $211,500 tax — roughly double the startup concession outcome. See BlueRock's ESS startup concessions case study for a practical walkthrough.

The startup concession eligibility checklist (all conditions must be met simultaneously):

• Company: incorporated <10 years; not listed on an ASX or overseas stock exchange; aggregated turnover <$50M in the prior year; Australian resident for tax purposes
• Employee: holds ≤10% of the company's shares post-grant; genuine employee (not contractor); arm's length terms
• Options: exercise price ≥ market value of the underlying share at the date of grant
• Holding: minimum 3 years from grant date, or until cessation of employment (whichever is earlier)

LI 2025/16 update (effective 1 October 2025): The ATO's Legislative Instrument ESS 2015/1 — which prescribed approved valuation methods giving companies binding Commissioner treatment — was replaced by LI 2025/16 from 1 October 2025. The new instrument maintains two safe harbour valuation methods (Method One: comprehensive method; Method Two: net tangible assets method) but renumbers them. Companies with existing plans should confirm their valuation method aligns with LI 2025/16. See the ATO ESS news and updates page for the full instrument. Confirm with a tax adviser when setting or reviewing your option valuation methodology.

No — these caps were repealed in 2022 and no longer apply. Prior to the Treasury Laws Amendment (Employee Share Schemes) Act 2022, certain ESS deferred-tax schemes imposed an annual monetary cap of $30,000 and a cumulative cap of $150,000 per employee on interests that could be held under the deferred-tax concession. These restrictions were entirely removed by the 2022 reforms.

Additionally, the 2022 reforms removed the salary sacrifice cap of $5,000 per year, allowing unlimited pre-tax salary sacrifice into eligible ESS interests at a discount of up to 15% (startup concession). Disclosure obligations were also streamlined: companies with fewer than 100 employees can now offer ESS interests under reduced disclosure rules.

What to do: If your ESOP plan rules, offer letters, or cap table management platform still reference the $30k/$150k caps or the old $5k salary sacrifice limit, have a lawyer update those documents. The only remaining monetary cap for non-startup ESS schemes is the $1,000 upfront reduction for broadly-offered taxed-upfront schemes (employees earning ≤$180,000 adjusted taxable income). See Cake Equity's startup tax concession guide for a current plain-English summary.

Phantom equity (also called synthetic equity) is a contractual arrangement that pays employees a cash amount equal to what they would have received had they held real shares — without issuing any actual shares or changing the cap table. A phantom unit is assigned a base price at grant (e.g., $2.00); if the company exits at $10.00, the employee receives $8.00 cash per unit.

When Australian startups use phantom equity:

• Incentivising contractors or overseas employees who cannot access the ESS startup concession (which requires genuine Australian employment)
• Avoiding cap table dilution before a major fundraise, where adding new shareholders would complicate the round
• Companies with complex structures (trusts, international subsidiaries) where issuing shares is administratively costly
• Situations where the company cannot satisfy the startup concession criteria (e.g., incorporated >10 years, listed, turnover >$50M)

Critical tax difference: Unlike real options under the startup concession (~23.5% effective rate on exit as shown above), phantom equity payouts are taxed as ordinary income at full marginal rates up to 47% — there is no CGT treatment and no 50% discount. Payroll tax (4%–6.85% depending on state) is also triggered at payout. Phantom equity is also subject to employer super obligations in certain structures. See Carta's phantom equity explainer for a comparison framework. Phantom equity is best treated as a last resort or a specific tool for non-resident/contractor situations rather than a default employee incentive.

Three platforms dominate ESOP administration for Australian companies:

Practical guidance: For most Australian pre-Series B startups, Cake Equity is the default choice given its AU-native compliance, ATO reporting integrations, and significantly lower cost than Carta. Switch to Carta when a US VC lead investor requires cap table visibility on their standard platform. See Pulley's Carta competitors guide for a detailed comparison.

These hand-picked videos and podcast episodes go deeper on the topics in this guide. We've favoured Australian creators, advisers and founders, with a few standout global explainers where the concept is universal. Each link was checked to confirm it is live at the time of publishing; treat any figures, tax rates or thresholds mentioned in older clips as point-in-time and cross-check against the current rules above.

Watch

• [AU] Startup Founder Guide to ESOPs | LegalVision — LegalVision (2022). Australian-specific 44-min webinar on ESOP fundamentals: startup tax concessions, safe-harbour valuations, ATO reporting, state-based taxes, information statements — co-presented with Pitcher Partners accountant. Primary AU reference for ESOP legal setup.
• [AU] Employee Incentive Schemes: Alternatives to Startup Concessions | LegalVision — LegalVision (2023). Covers what happens when a startup outgrows the ESS startup concession — taxed deferred options, limited resource loan share plans, phantom share schemes — with William Buck accountant. Directly addresses the gap founders hit post-$50M turnover threshold.
• Startup Equity Matters | Ep. 32 WTF is an ESOP? — Cake (2024). Jason Atkins (Cake Equity, AU Gold Coast) explains ESOP from the employee perspective: granting, vesting, exercising, exits, and the AU startup concession tax treatment — accessible explainer for founders explaining equity to their team.
• Startup Equity Matters | Ep. 20 The State of Aussie Startup Employee Equity 2024 — Cake (2024). Data-driven look at the Australian startup equity landscape in 2024: how much equity AU startups are granting, employee motivation drivers, how valuations are communicated, and the gap between equity promise and employee understanding — backed by Cake's survey.

Listen

• WTF is an ESOP? | Episode 32 — Startup Equity Matters (Cake Equity) (2024). Full podcast episode page for the Cake Equity show's ESOP explainer, available on Apple Podcasts and Spotify — useful as an audio companion to the YouTube version for Australian founders and their teams.