ESS For Private Companies: Options, Shares Or Phantom Equity

If you’re building a startup or growing a small business, you’ve probably felt the tension between wanting to hire great people and needing to manage cash carefully.

That’s where an employee share scheme (often called an “ESS” or “ESOP”) can be a genuinely practical tool - not just a “big tech company” idea. For many founders, a well-structured employee share scheme helps attract talent, reward performance, and align your team around the same long-term goal: building a valuable business.

But setting up an employee share scheme for a private company in Australia isn’t just about picking a percentage of equity and sending a friendly email. You’re dealing with corporate law, tax rules, valuation issues, and the day-to-day reality that people join, leave, get promoted, and sometimes don’t work out.

This guide walks you through the essentials - from the types of schemes private companies commonly use, to the legal documents you’ll typically need, and the practical decisions that can make (or break) your plan. It’s general information only (not legal or tax advice), and it’s worth getting advice tailored to your company before you make offers.

What Is An Employee Share Scheme (And Why Private Companies Use Them)?

An employee share scheme is a structured way for your company to grant equity (or equity-like rights) to employees and sometimes directors or contractors. In plain terms, it’s a way to give team members a stake in the upside if the business grows.

For private companies, the main reasons we see founders implement an employee share scheme are:

• Attracting talent: especially when you can’t match larger businesses on salary.
• Retention: equity that vests over time can encourage people to stay.
• Alignment: the team benefits when the company’s value increases.
• Rewarding key contributors: without needing immediate cash bonuses.

If you’re looking into an employee share scheme for a private company in Australia, you’re usually looking for a setup that works without the complexity of a public company environment - while still being legally solid and fair to everyone involved.

One important mindset shift: an employee share scheme is not “set and forget”. It becomes part of your company’s governance and culture. That’s why it’s worth investing time upfront to design it properly.

Which Type Of Employee Share Scheme Works Best For A Private Company?

There isn’t one “best” ESS structure. The right option depends on your business model, how fast you’re growing, your funding plans, and what your team actually values.

Here are the common structures private companies use in Australia.

1) Options (The Most Common Startup Approach)

An option is a right to buy shares in the future at a pre-set price (the “exercise price”). Options are popular because employees don’t become shareholders immediately - which can keep your cap table cleaner early on.

Options are often paired with vesting (for example, 4 years with a 1-year cliff) so employees earn the right to exercise over time.

Practical considerations for options:

• What happens if the employee leaves before vesting?
• How will you set the exercise price (and how often will you update valuation)?
• What happens on a sale of the company (acceleration, forced exercise, cashless exercise)?

2) Shares (Immediate Ownership, More Governance Complexity)

Some private companies issue shares to employees upfront (sometimes at a discount, sometimes with restrictions). This gives immediate ownership, which can feel very tangible for employees.

The trade-off is that it can introduce more governance and admin complexity - you may end up with more shareholders earlier, and you’ll want clear rules around transfers, leavers, and decision-making.

In many cases, this is where a strong Shareholders Agreement becomes essential, because you’ll want a consistent framework for what shareholders can and can’t do.

3) Rights / “Phantom” Equity (Equity-Like Rewards Without Issuing Shares)

Some businesses use equity-like incentives that track company value but don’t actually issue shares (for example, “phantom shares” or share appreciation rights).

This approach can be attractive if:

• you want to avoid increasing shareholder numbers;
• you want more control over who becomes an actual owner; or
• you want a benefit that pays out on an exit event.

However, these arrangements can still have tax and legal consequences, and they need careful drafting to avoid misunderstandings about what employees are truly receiving.

4) ESS Via An Employee Share Trust (More Complex, Sometimes Useful)

Some private companies use an employee share trust (EST), often for administrative or tax planning reasons. This is typically more complex and usually comes up when you’re scaling, issuing equity regularly, or preparing for larger funding rounds.

If you’re early-stage, you may not need a trust structure straight away - but it can be worth discussing if you expect rapid growth or frequent equity grants.

Key Legal And Tax Issues You Need To Think About Before Offering Equity

An employee share scheme can be a powerful tool, but it’s also an area where “quick templates” can create long-term risk. Before you start making offers, you’ll want to understand the legal and tax framework at a high level - and get advice where needed, because the details can change the outcome.

Shareholder Rights, Control, And Decision-Making

Even in a friendly startup, equity is still ownership. If you issue shares (or options that turn into shares), you need to be clear on:

• Whether employees get voting rights (and if so, when).
• Whether shares are subject to restrictions on transfer (they usually should be).
• How future fundraising will dilute holders.
• How leavers are handled (good leaver vs bad leaver outcomes).

This is also where your company’s governance documents matter. For example, your Company Constitution may need to work alongside the ESS rules - particularly around share classes, transfers, and director powers.

Tax Treatment (Including Employee Share Scheme Tax Rules)

In Australia, employee share schemes have specific tax rules. The tax outcome can differ depending on whether you’re granting shares, options, or rights, and whether the scheme qualifies for certain concessions. The rules can be complex, and employees can have different tax outcomes depending on their circumstances - so you should avoid making tax promises and encourage employees to get their own independent advice.

From a business-owner perspective, the practical takeaway is:

• tax timing matters (when an employee is taxed can affect how attractive the offer is);
• documentation matters (the ATO expects the scheme to be properly structured); and
• communication matters (employees will have questions, and unclear answers can create friction).

It’s also common to coordinate legal setup with accounting/tax advice so your offer aligns with your financial strategy.

Valuation (How Much Is The Company “Worth” For The Scheme?)

Private companies don’t have a market price like public companies do, so valuation is a recurring issue.

You might need valuation for:

• setting an option exercise price;
• determining a discount on shares;
• explaining value to employees; and
• making sure the scheme aligns with tax requirements.

Valuation doesn’t have to be a “perfect number”, but it should be defensible, consistently applied, and appropriate for the purpose (including any tax-related requirements).

Disclosure And Offer Process

When you offer equity, you’re not just “giving a benefit” - you’re making an offer involving ownership or ownership-like rights. Depending on how you structure the offer and who you’re offering it to, there may be disclosure and compliance requirements (including under the Corporations Act), so it’s worth getting advice before you roll the scheme out.

At a practical level, your offer should be clear about:

• what exactly is being offered (shares vs options);
• when it vests and what conditions apply;
• what happens on exit or termination;
• whether the employee needs to pay anything (exercise price, tax, etc.); and
• any restrictions on selling or transferring the equity.

This is one of the reasons founders often prefer a structured scheme with a consistent set of rules, rather than negotiating something different with each hire.

How Do You Set Up An Employee Share Scheme For A Private Company In Australia?

If you want a practical roadmap, here’s a typical setup process for an employee share scheme in an Australian private company.

1) Decide What You’re Trying To Achieve

Start with the business goal, not the legal document.

• Is this mainly for retention of key hires?
• Are you competing for talent with larger employers?
• Do you want everyone to have equity, or only senior roles?
• Are you planning to raise capital soon?

The answers affect how big the employee pool should be, what vesting looks like, and how “shareholder-heavy” you want your company to become.

2) Choose The Equity Instrument (Options vs Shares vs Rights)

For many startups, options are the cleanest place to begin - but it’s not automatic. If you want employees to feel true ownership from day one, shares might suit. If you want to avoid issuing shares altogether, equity-like rights might be better.

The right structure is the one that your team can understand, your company can administer, and your growth plan can support.

3) Design The Commercial Rules (Vesting, Cliffs, Leavers, Acceleration)

Most of the “real world” issues with ESS happen here, not in the company register.

Common design decisions include:

• Vesting schedule: eg monthly vesting over 4 years.
• Cliff: eg nothing vests until 12 months of service.
• Good leaver / bad leaver: what happens if someone resigns, is terminated, becomes ill, or is made redundant.
• Acceleration: does vesting speed up if the company is sold?
• Exercise window: if someone leaves, how long do they have to exercise options?

These rules need to be consistent, clearly drafted, and fair - because you will likely rely on them in a stressful moment (like an exit, a restructure, or a dispute).

4) Prepare The Legal Documents

This is where you turn the business plan into enforceable terms. While every ESS is different, many private companies will need some combination of:

• ESS plan rules: the overarching rules of the scheme.
• Offer letter / invitation: the specific grant details for each employee.
• Option agreement or share subscription agreement: the contract that actually implements the grant.
• Board and shareholder approvals: depending on your company structure and documents.
• Updates to governance documents: eg aligning transfer restrictions or share classes.

It’s also common to connect the scheme with your hiring process, so that equity offers sit neatly alongside your Employment Contract and don’t contradict other terms (like confidentiality, termination, or notice periods).

5) Build In Confidentiality And IP Protection

Equity incentives often go hand-in-hand with senior hires getting access to sensitive information: product roadmaps, source code, financials, and fundraising plans.

That’s why many businesses ensure confidentiality terms are robust, and sometimes also use a standalone Non-Disclosure Agreement for external discussions (for example, when someone is advising your team before they formally join).

Just as importantly, make sure your business has clear IP ownership arrangements (so the value you’re sharing is actually protected).

6) Keep Good Records And Cap Table Accuracy

Once your scheme is running, admin becomes part of compliance. You’ll want a reliable process for:

• tracking vesting dates and performance conditions;
• approving grants and maintaining written records;
• updating your cap table after exercises or share issues; and
• handling departures consistently.

Many founders underestimate how quickly equity admin can become a time drain if the scheme is not structured with simplicity in mind.

What Legal Documents Will You Commonly Need For An Employee Share Scheme?

There’s no one-size-fits-all pack, but as a practical checklist, here are documents that often matter when you implement an employee share scheme in a private company.

• ESS plan rules: sets the framework for eligibility, vesting, leavers, exercise rules, and what happens during a sale or restructure.
• Offer letters / grant notices: specifies the number of options/shares, vesting schedule, and any special terms for the individual.
• Option agreement / share issue terms: the core agreement that implements the grant and is enforceable if there’s a dispute.
• Company Constitution: may need updates so share transfers and share classes work smoothly; this is often aligned through a Company Constitution.
• Shareholders Agreement: helps manage decision-making, transfer restrictions, and exit mechanics as your shareholder base grows; often supported by a Shareholders Agreement.
• Employment documentation: your equity offer should sit consistently with your Employment Contract, especially around termination and post-employment obligations.

Not every business will need every document listed above, but most startups will need a combination of them to make the scheme enforceable and manageable.

Common Mistakes We See With Private Company Employee Share Schemes (And How To Avoid Them)

Most ESS problems aren’t caused by founders having the “wrong intentions”. They happen because the scheme wasn’t designed for real life.

Offering Equity Without Clear Leaver Terms

People leave - even good people. If your scheme doesn’t clearly deal with resignation, termination, redundancy, or long-term leave, you can end up negotiating under pressure.

Clear good leaver / bad leaver rules can prevent uncertainty and protect morale.

Not Aligning The Scheme With Fundraising Plans

If you plan to raise capital, investors will want clarity around your option pool, dilution impact, and approvals.

It’s usually easier to design the pool early than to “retrofit” it mid-round when timelines are tight.

Making Verbal Promises (Or Loose Email Commitments)

Equity is emotionally significant. A casual “we’ll give you 1%” can become a serious expectation.

You can still move fast, but you should aim to put equity offers in writing with clear terms before someone relies on them.

Underestimating Admin And Compliance

If your scheme requires lots of manual tracking, you’ll feel it within a year. Simple vesting rules, consistent documents, and a clear approval process go a long way.

Not Explaining The Offer In Plain English

Even a perfectly drafted ESS can backfire if employees don’t understand what they’re getting.

You don’t need to overload them with legal detail - but you should clearly explain:

• what they own (or could own);
• what they need to do to get it (vesting/exercise);
• what it could be worth (and that value is not guaranteed); and
• what happens if they leave.

Key Takeaways

• An employee share scheme can help private companies attract and retain talent, but it works best when it’s designed around your real business goals.
• Options, shares, and equity-like rights can all work in Australia - the best structure depends on how much complexity you want, your governance setup, and your growth plans.
• For an employee share scheme in an Australian private company, the “commercial rules” (vesting, leavers, exercise windows, exit events) are often the most important part to get right.
• Your scheme should align with your core governance documents, including your Company Constitution and (often) a Shareholders Agreement, so you’re not creating conflicts later.
• Clear documentation and communication reduce disputes, support fundraising, and make the scheme easier to administer as your team grows.

If you’d like help setting up an employee share scheme for your private company in Australia, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.