ESOP or ESS: Which One Is Right For My Business? (2025 Updated)

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Creating a culture of employee loyalty and engagement in the era of side hustles can be a challenging yet rewarding endeavour. In today’s competitive market, it’s crucial to invest in strategies that not only attract talent but also foster long‐term commitment.

One way to do this is to give employees ownership through either an Employee Share Option Plan (ESOP) or an Employee Share Scheme (ESS).

ESSs directly issue employees shares, while ESOPs grant employees the opportunity to acquire shares in their own company via share options.

ESOPs and ESSs are typically used to motivate and reward employees. As of 2025, ESOPs have grown in popularity globally – with recent estimates indicating there are now over 7,000 plans covering nearly 16 million people in the United States, and Australian companies are increasingly embracing these schemes following ongoing tax reforms (source). For more detailed insights on how you can implement these strategies within your business, you might also want to review our Employee Share Option Plan guide.

If you’re looking to get your employees more invested in the business, an ESOP or an ESS may be the best strategy for you!

How Can An ESOP Or ESS Be Taxed?

Employees are generally taxed on the value of the shares or options that they receive. The Australian Taxation Office (ATO) treats these grants as assessable income, which is then subject to income tax. Unlike wages (which are subject to PAYG withholding), the responsibility for paying this tax falls on the employee. For further details on taxation and broader regulatory obligations, you might review our article on Regulations Affecting Your Corporation.

There are three different ways in which an employee can be taxed on a grant under an ESOP or ESS, as follows:

Taxed upfront scheme: This is the default position where an employee must include the value of the grant in their assessable income in the year they acquire an ESS interest (whether it is an option or a share).
Deferred tax scheme: Under this arrangement, the tax payable can be deferred for up to 15 years, subject to certain conditions being met. You can find further details on these conditions here.
Start Up Concession scheme: In this scheme, the discount on the share is not reported as income, so no income tax is payable either upfront or deferred. Instead, the shares are taxed under the Capital Gains Tax provisions.

In this article, we focus on ESS and ESOPs with respect to the Start Up Concession scheme – a popular option in 2025 for innovative startups.

Key Factors To Consider

What Is It?

With an ESS, a company allows its employees to purchase its shares, often at a discount off the fair market value. The shares may vest in tranches over a predetermined period or upon the achievement of specific company-wide or individual KPIs. This approach helps align employees’ interests with the long-term success of the business.

If an employee leaves the company, the rights to any unvested shares typically lapse automatically, and the company may repurchase the vested shares at either fair market value or a discounted rate depending on the circumstances. For expert advice on structuring share schemes, consider exploring our Company Registration services to build a robust foundation for your ESS.

How Do Employees Participate?

Under the Start Up Concession scheme, if you have an ESS, at least 75% of your Australian permanent employees with three or more years of service must be (or have been) entitled to ESS interests in the company. This criterion is designed to maintain a broad base of employee engagement, which is essential for your company’s growth into 2025 and beyond.

How Do Employees Engage?

ESS arrangements are typically straightforward for employees to understand, as most people are familiar with shares as opposed to share options. This clarity can lead to higher overall employee engagement.

What Rights Do Employees Get?

When you employ an ESS, you issue ordinary shares to your employees, granting them the same rights as other shareholders. This includes entitlements to dividends and voting rights at the company’s general meetings – key benefits that foster a greater sense of ownership and loyalty.

How Much Will It Cost?

Employees are generally required to pay a minimum of 85% of a share’s market value upfront. This cost structure ensures that employees have a meaningful stake in the business, which aligns their interests with your company’s long-term success.

Things To Remember

Keep in mind that a private company in Australia (any Pty Ltd) is generally limited to having no more than 50 shareholders. This is an important consideration when setting up your ESS to avoid potential future complications.

What Is It?

With an ESOP, the company issues employees with options to purchase ordinary shares. These options vest over time, and once vested, employees can exercise their options by paying the predetermined exercise price to acquire the underlying shares.

How Do Employees Participate?

Unlike ESSs, ESOPs do not impose mandatory participation requirements. Companies have the flexibility to distribute share options to as many employees as they choose, making it a versatile tool for rewarding performance.

How Do Employees Engage?

One challenge with ESOPs is that many employees may initially struggle to grasp the concept of share options, potentially undervaluing them compared to directly held shares. This often requires additional education and support; for a clearer understanding, refer to our comprehensive Employee Share Option Plan guide.

What Rights Do Employees Get?

The shareholder rights associated with an ESOP only come into effect once the option has vested and the employee exercises it to purchase shares. At that point, the employee enjoys the full benefits of ordinary share ownership, including dividend rights and voting power.

How Much Will It Cost?

When an option vests, the employee must pay the exercise price, which is set at or above the fair market value of the underlying shares on the grant date. This approach ensures fairness and transparency in valuing the share options.

Things To Remember

Although ESOPs grant the option to obtain share ownership, the associated shareholder rights do not become active until the options are exercised. This distinction is important when explaining the benefits of an ESOP to your team.

Reforms to ESS and ESOPs in Australia

Since July 2015, the ATO has introduced a series of startup concessions for employees participating in ESS and ESOP schemes, with further refinements evolving into 2025. These concessions enable employees to defer tax on their share or option grants until they receive a financial benefit, such as the vesting of shares or the exercise of options. The concession remains available for interests acquired after 30 June 2015, forming a key pillar of modern employee ownership strategies.

Under these reforms, companies must meet specific criteria to allow their employees to access the tax and concession benefits. For example, your startup must be a private company incorporated within the last 10 years, have an aggregate turnover below $50 million, be an Australian resident company, and ensure that employees hold their ESS interests for at least three years. Additionally, the discount offered must not exceed 15% of the share’s market value, and any share options must carry an exercise price at or above the fair market value.

For additional clarity on the regulatory environment, you might find our article on Regulations Affecting Your Corporation particularly useful.

On that note – did you know that there is a special startup valuation process designed to help companies ensure their employees can fully take advantage of these tax concessions? You can review the two valuation methods here.

Changes From 1 July 2025

Effective 1 July 2025, several updates have been introduced to the laws governing ESS and ESOPs for small businesses. Firstly, an employee leaving the business will no longer automatically trigger a tax event. Instead, taxation will only occur when an employee has realised a genuine financial benefit that adequately covers the tax cost.

Secondly, unlisted companies can now award grants worth up to $40,000 every 12 months where an employee is required to make a payment—a significant increase from the previous $5,000 cap. This change provides unlisted companies with greater flexibility to attract and retain talent by offering equity packages that are competitive with those of listed companies. For more updates on legislative changes, check out our Legal Requirements for Starting a Business article.

Talk to a Lawyer

ESS and ESOPs can be extremely valuable to your company – both for the employee and the employer. If you’re looking for a way to retain talent and incentivise your team, then an ESS or ESOP could be highly beneficial. For more detailed guidance, do consider reviewing our resources on Contractor Agreements to ensure that every element of your employment structure is compliant.

There are many rules that need to be adhered to, so it’s best to have a chat with one of our lawyers. We’d love to help create a plan for your business that is both rewarding and compliant with the latest regulations. You might also find our Small Business Legal Essentials guide useful for quick tips and updates.

If you need help, drop us a line at team@sprintlaw.com.au!

As the business landscape continues to evolve in 2025, staying informed about legislative updates is more critical than ever. Regularly reviewing resources such as our guides on Regulatory Compliance and Company Registration can help ensure your employee share schemes remain robust and effective. This proactive approach will keep your business competitive and secure well into the future.

Abinaja Yogarajah

Abinaja is a the legal operations lead at Sprintlaw. After completing a law degree and gaining experience in the technology industry, she has developed an interest in working in the intersection of law and tech.