Are you a start-up founder who has issued shares to employees? Read this

Are you a start-up founder who has implemented an employee share scheme (ESS) as a way to attract and retain key employees? There are new rules coming that could make it difficult for you to achieve that all-important second goal — employee retention — without proper planning when implementing an ESS.

ESSs allow employees to own a share of the company they work for. They can be suitable for both private and public companies, large and small. They are particularly popular among startups because they are an attractive alternative remuneration model and have the added benefit of motivating staff. Increasingly, demand for ESSs are coming from the employees themselves who want to be owners in the business. They really can be a win-win for all.   

However, the federal government is reported to be introducing legislation that will allow employees issued shares by their employer to leave their job without the same tax implications as before. Under the reported new rules, employees issued shares or options as part of an ESS will not be taxed if they cease employment.

This is of course good news for the individual looking to leave. But not so great for the startup because it will make it easier for employees to take their shares with them, negating in part the purpose of offering an ESS in the first place.  

News reports say it will make it easier for employees to quit their jobs and launch their own startups, thus creating new companies, innovations and jobs in the economy. But what about the startup that is left with a potential competitor now holding its shares?

Having an ex-employee holding shares raises significant competitive issues for a startup, particularly with the voting rights and access to information that comes with it. Additionally, it limits the availability of shares for existing and future employees in what are often less than 10-employee companies. 

Going forward, startups and other small businesses looking to retain staff through an ESS will need to ensure their plan stipulates what will happen if an employee leaves the business. It is possible to add wording to ESSs that require employees to redeem their shares when they leave. However this won’t help startups that already have a plan in place. 

The new rules are part of a slew of recommendations proposed in August by the House of Representatives Standing Committee on Tax and Revenue in its Owning a Share of Your Work: Tax Treatment of Employee Share Schemes report.

There were many good points in the proposals, one of the key being to reduce the administration and compliance burden of setting up an ESS. Another relates to better utilisation of employee share trusts, which are popular in the UK and increasingly so here based on growing interest among the clients I work with. But these require specialist advice and would benefit from simpler rules at a legislation level. 

However, based on what is being reported, it looks like most of the 18 recommendations have not made it through to legislation, a missed opportunity for startups and other small businesses. 

My concern is that the big change being reported — making it easier for employees to retain their shares when they leave the company — could hurt the startup or small business being left behind. We’ll wait to see what the rest of the rules contain when they are introduced.