Making a Start With Employee Ownership – Startups and Employee Share Schemes

With taxation “handbrakes” on employee involvement in financing startups now removed, Alan Greig from Employee Ownership Australia explains how to make the most of these concessions.

The popularity of startups today is being driven by two defining characteristics. Firstly, their potential for high growth and, secondly, their role in disruptive innovation. Established small businesses generally are seen to lack these characteristics.

StartupAUS, in its Crossroads Report earlier this year, defined a startup as “an emerging high-growth company that is using technology and innovation to tackle a large and most often global market”.

With about 1,500 startups in Australia playing a significant role in the development of the economy, they are seen as critical to lifting productivity, competition, economic growth and employment through the creation of, and access to, new markets and the invigoration of established markets. The indications are that startups are creating most of the new jobs, while established businesses are shedding most of the job losses. As a result, startups will potentially contribute $109 billion and 540,000 jobs to the Australian economy by 2033.  

Innovation-active companies are significantly more engaged in the digital economy, earning more than three times that of non-innovators. Innovation is encouraging a more connected and skilled economy, with greater market diversity and consumer choice. There are many startups active in the field of social entrepreneurship, especially in the human services markets which are opening up in disability services and aged care provision.  

To encourage these developments, the federal government’s National Science and Innovation agenda provides a range of incentives. As part of this program, in 2015, the federal government passed the tax and superannuation laws amendment (employee share schemes) bill to remove what were seen as taxation “handbrakes” on employee involvement in the ownership and financing of startups.

What is so important about this issue to justify this policy position? The answer can be seen in the report Employee Ownership Australia (EOA) released in 2014, called Employee Share Schemes – Their Importance to the Economy, which describes in detail the link between employee ownership and productivity, along with the impact that employee involvement in the ownership of businesses has on the performance of those businesses, both socially and economically.

Highlighting this link is the following data from the US National Centre for Employee Ownership.  These impacts indicate the “purpose” and “social value” of employee ownership.

1. Employee ownership keeps businesses and jobs in local communities

• Employee owned companies are 25 per cent more likely to survive than comparable non-employee owned companies.
• Employee-owners were four times less likely to be laid off during the recent recession than employees who did not own shares in the business which employed them.
• Employee owned companies never close for reasons of moving to other countries.

2. Employee ownership improves business performance

• Productivity improves by 4 per cent to 5 per cent on average in the year an employee share ownership plan (ESOP) is adopted, and the higher productivity level is maintained in subsequent years.
• ESOPs increased sales, employment, and sales per employee by about 2.3 per cent to 2.4 per cent per year.
• ESOP companies had on average an 8.8 per cent higher sales per employee than their non-ESOP counterparts in the same industry and same size.
• Private-company-based ESOPs had job growth of 60 per cent between 2001 and 2011 while other companies remained flat.

3. Employee ownership builds community wealth

• Employees at ESOP companies have additional retirement savings that are 2.2 times greater than at comparable, non-ESOP companies.
• On average, employees at employee-owned companies receive 5 per cent to 12 per cent more in wages.

This evidence shows that more widespread “stakeholder ownership” within social policy – rather than return on investment – will be the foundation for the following:

• increasing prosperity through distributing wealth more broadly
• rebalancing the economy through tackling the causes of poverty and inequality
• enhancing business accountability and social performance
• increasing community wellbeing
• creating more satisfying, productive and happier workplaces.

Employee share schemes (ESS) are an important part of the wider stakeholder ownership movement.

Within startups, ESS enable employees to take up “share options” as part of their salary, with the latter component being income free, tax free to them if certain conditions / pre-qualifications are met. It is important to note however, that employees choosing to swap current salary for a share in the future wealth of the company is not risk free, but does provide an incentive for those employees keen to be cut into the capital side of the business as “owners”. For the startup, a benefit is that pressure is also taken off the all-important cash flow of the startup (through reduced monthly salary outgoings).

To implement the new ESS tax law, the Australian Tax Office (ATO) has produced an excellent how to website, with all the required information/guidance on accessing the tax concession. For example, see ESS Basics and the startups template Standard Documents for the Start-Up Concession.

In these documents, the ATO sets out the conditions that companies must meet in order to access the tax concession:

Startup company

For ESS purposes, a company is a startup for an income year if at the end of its most recent income year before the ESS interest was acquired in it:

• the company and any subsidiaries or its holding company and any subsidiaries were not listed on a stock exchange
• had been incorporated for less than 10 years
• the company’s aggregated turnover did not exceed $50 million.

Startup concession

A tax concession is available to an employee with ESS interests in a startup company provided that the scheme meets certain conditions:

• the employer (which may or may not be the company issuing the ESS interest) is an Australian resident company
• the employee meets the less than 10 per cent ownership and voting rights test
• the discount on an ESS interest that is a share is no more than 15 per cent of its market value at the time it is acquired
• the amount payable to exercise an ESS interest that is a right is greater than or equal to the market value of an ordinary share in the company when the right is acquired.

Employee Ownership Australia (EOA) fully supports these developments and was instrumental in the lobbying efforts to bring them about.

Understanding ESS startup changes. Source: EOA

EOA is currently producing a video, Conversations With Five Startups With Employee Ownership.

One of the companies is Culture Amp, an inspirational story, as one of the first companies to take up the ESS tax concession. Culture Amp – like many startups today – makes provision for social objectives through allocating a proportion of its profits to social causes. Culture Amp won EOA’s 2016 ESOP of the Year Award in the SME category.     

As a new Australian tech startup, Culture Amp has grown to 55 employees based in Australia and North America. Associated with this growth, Culture Amp decided early on to offer share options to all of its staff, with the amount each individual is offered varying according to role, the skills involved, and how early the employee joined the company – with the main reason for offering such shares being to create a sense of ownership in the company amongst employees and to avoid internal competition based on salary.

Culture Amp believes that for a startup to be competitive in the market in terms of the salary offered, employee shares must be included, along with an explanation as to how they can be of value to every individual employee. Employee shares can be a really powerful motivator.

“Most importantly you’re now an owner, you’re looking at something that is yours when you walk in, and it’s hard to underestimate the power of that especially if you can build that in early,” Culture Amp co-founder and chief executive Didier Elzinga said.

“It is incumbent in putting this in place to take employees through how the plan works so it is seen as a good offer, and not something clouded in mystique and uncertainty.”

If you are a startup or ordinary business wanting more information about the employee ownership advantage, visit Employee Ownership Australia Ltd.  

About the author: Alan Greig is a board member of Employee Ownership Australia Ltd, a director of The Mercury Centre Cooperative Ltd and coordinator of the Social Enterprise Legal Models Working Group.