Deloitte/Norton Rose ESOP survey report Australian business experiences with Employee Share Options

Deloitte/Norton Rose ESOP survey report Australian business experiences with Employee Share Options

Introduction As Deloitte Private and the other authors argued in the report of November 12, Silicon Beach: A study of the Australian Startup Ecosystem, Employee Share Option Plans (ESOPs) could be a potentially helpful, flexible and low-cost way for startup businesses to compensate employees. However, in Australia, the tax rules surrounding ESOPs make them unfortunately quite difficult and expensive to use, in contrast to many other jurisdictions whose businesses make much more common use of them. As a follow up to that earlier report, and to gain a better understanding of this important issue and of the Australian technology community s views on the value and complexity of ESOPs in incentivising employees, Deloitte and Norton Rose conducted a survey of 14 businesses from startups to established companies in late January and early February 13. The survey s results, presented here, are illuminating. The same or better rules that apply in the U.S. and the UK should apply in Australia Survey Participant Startups are usually and of necessity intent on preserving their limited capital and therefore looking for low-cost solutions to paying for their business costs. ESOPS have been shown to be very useful, especially in the United States, as a way to attract, motivate and share the rewards of success with the dedicated employees who help build the business from the beginning. Yet, in the Australian taxation environment, ESOPs are cumbersome to set up, and require a good deal of expensive professional help to comply with all of the regulations to which they are subject. More importantly, the taxation of ESOPs in the hands of the employee at the time of issue, rather than at the time they received the proceeds, is the main obstacle to more widespread use. There are some significant issues with compensating startup employees: it is still difficult to establish a simple employee share option plan (ESOP) which can motivate the entrepreneurial talent essential to startup innovation Deloitte Private, Pollenizer, From Little Things, Startup Genome and Vivid, Silicon Beach: A study of the Australian Startup Ecosystem, p. 25 1 Deloitte/Norton Rose ESOP survey report

Survey results Deloitte and Norton Rose found in our survey that there is a real appetite on the part of startups (94 per cent of whom agreed or strongly agreed) to use ESOPs and that they are viewed as potentially very helpful to incentivise employees and to attract the calibre of employees necessary to get their businesses off the ground. The rules need to be flexible enough to permit start-up and innovation entities to issue share options to employees so that the taxing point coincides with when the employee realises or has control of the financial benefit. The non-cash benefit of share options is an excellent benefit for cash strapped enterprises to use to attract high-potential candidates/personnel whose rewards will only be recognised if returns are achieved for shareholders Survey Participant Do you think that share options are a valuable way to incentivise employees? 7 6 62 5 4 3 32 1 5 Strongly disagree 1 Disagree Agree Strongly agree In the main, however, startup entrepreneurs were of the view that ESOPs were too expensive and cumbersome to use, with the result that staff compensation costs burn through more startup capital than would be necessary if ESOPs could be used more efficiently to offset compensation expenses. Do you consider the issuing of share options to Australian employees so complex that it is a disincentive to issuing share options? 1 8 82 6 4 Yes 13 No 5 Don t know Australian business experiences with Employee Share Options 2

To what extent do you consider the issuing of share options so complex that it is a disincentive to issuing share options? 8 75 6 4 24 1 To a low extent To a medium extent To a great extent As a consequence of the unfavourable tax implications of ESOPs, only 37 per cent of respondents had used them in the last three years. Of those who had not issued ESOPs in the past three years, 81 per cent agreed or strongly agreed that tax considerations were the main consideration for their reluctance to utilise them, while 82 per cent agreed that tax considerations were a disincentive to their use. In addition, of those 81 per cent of respondents who felt that tax considerations of issuing share options were a disincentive, 75 per cent felt that the complexity was a disincentive to their use to a great extent, with a further 24 per cent of the view that it was a disincentive to a medium extent. Only 1 per cent felt it was a disincentive to a low extent. Were the tax consequences on the employee a significant reason for not issuing share options? 8 6 64 4 13 17 3 Strongly disagree Disagree Agree Strongly agree 3 Don t know There was a clear consensus among respondents as to the main obstacle to the use of ESOPs: the vast majority fully 89 per cent of respondents would be more inclined to issue share options if employees were taxed on financial gains at the time of ESOP proceeds rather than earlier. 3 Deloitte/Norton Rose ESOP survey report

If employees were taxed on financial gains made at the time the ESOP proceeds were actually received rather than earlier, would you be more inclined to issue share options? 6 5 52 4 37 3 1 5 Strongly disagree 2 Disagree Agree Strongly agree 4 Don t know ESOPs allow startups to offer employees a share in the increase in business valuation that they contributed to. A well-structured ESOP allows a company to conserve cash burn while at the same time reward employees for their efforts. The tax environment in Australia makes ESOPs expensive to put together for both companies and employees. We believe that a modified tax regime for startup ESOPs would motivate more startups to implement such a scheme and thereby motivate more people to take entrepreneurial risk. Without this, many startups may continue to struggle to attract and retain the local talent pool. Silicon Beach: A study of the Australian Startup Ecosystem, p. 25 Implications: What this means for Australia is that as a nation we risk losing valuable startups to friendlier jurisdictions that offer greater flexibility and make it easier to reach a larger scale. The Silicon Beach report found that Australian startups were already considerably less likely to reach scale as U.S. startups. The natural advantages offered by economies of scale in larger markets such as the U.S. and Europe cannot be discounted, but Australia is further disadvantaging its startup entrepreneurs by imposing unnecessary obstacles to the use of flexible arrangements, such as ESOPs, to help them grow their businesses here. Those obstacles boil down to two main issues: the complexity and therefore expense to set up an ESOP, and the current rules regarding the taxation of ESOPs in the hands of employees at the time they are awarded, rather than at the time the proceeds are received. If Australia is to compete on a level playing field, retain talented Australian entrepreneurs and generate a strong pipeline of startups, then these two issues must be addressed. Australian business experiences with Employee Share Options 4

Profile of survey respondents Survey respondents were drawn from five states and one territory, with 63 per cent from NSW and per cent from Victoria. They ranged in age, but nearly two-thirds were under 1 years old and 62 per cent had fewer than 3 employees, and more than half had revenues of less than $5 million, while only 25 per cent had revenues greater than $15 million. By State 7 6 63 5 4 3 1 NSW VIC 7 QLD 4 WA 4 SA 2 ACT NT TAS Age of companies 4 3 29 26 24 1 12 9 up to 3 years 4-5 years 6-1 years 11-25 years 26+ years 5 Deloitte/Norton Rose ESOP survey report

Number of employees 4 33 3 23 1 6 11 13 14 1 to 9 1 to 19 to 29 3 to 49 5 to 99 1+ Average revenue size of companies 4 3 27 29 25 19 1 < $1m $1m - $5m $5m - $15m > $15m Australian business experiences with Employee Share Options 6

Contact us Roan Fryer Tax Partner - Deloitte Tel: +61 2 984 729 email: rfryer@deloitte.com.au Nick Abrahams Partner - Norton Rose Tel: +61 2 933 8312 email: nick.abrahams@nortonrose.com www.deloitte.com.au www.nortonrose.com This publication contains general information only, and none of Deloitte Touche Tohmatsu Limited, its member firms, or their related entities (collectively the Deloitte Network ) is, by means of this publication, rendering professional advice or services. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser. No entity in the Deloitte Network shall be responsible for any loss whatsoever sustained by any person who relies on this publication. About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/au/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Deloitte provides audit, tax, consulting, and financial advisory services to public and private clients spanning multiple industries. With a globally connected network of member firms in more than 15 countries, Deloitte brings world-class capabilities and high-quality service to clients, delivering the insights they need to address their most complex business challenges. Deloitte has in the region of, professionals, all committed to becoming the standard of excellence. About Deloitte Australia In Australia, the member firm is the Australian partnership of Deloitte Touche Tohmatsu. As one of Australia s leading professional services firms, Deloitte Touche Tohmatsu and its affiliates provide audit, tax, consulting, and financial advisory services through approximately 6, people across the country. Focused on the creation of value and growth, and known as an employer of choice for innovative human resources programs, we are dedicated to helping our clients and our people excel. For more information, please visit Deloitte s web site at www.deloitte.com.au. Liability limited by a scheme approved under Professional Standards Legislation. Member of Deloitte Touche Tohmatsu Limited 13 Deloitte Touche Tohmatsu. MCBD_PER_3/13_48475 About Norton Rose Norton Rose is a leading international legal practice. We offer a full business law service to many of the world s pre-eminent financial institutions and corporations from offices in Europe, Asia, Australia, Canada, Africa, the Middle East, Latin America and Central Asia. Knowing how our clients businesses work and understanding what drives their industries is fundamental to us. Our lawyers share industry knowledge and sector expertise across borders, enabling us to support our clients anywhere in the world. We are strong in financial institutions; energy; infrastructure, mining and commodities; transport; technology and innovation; and pharmaceuticals and life sciences. About Norton Rose Australia Norton Rose is the business name for the international law firm that comprises Norton Rose LLP, Norton Rose Australia, Norton Rose Canada LLP and Norton Rose South Africa (incorporated as Deneys Reitz Inc) and their respective affiliates ( Norton Rose entity entities ). The purpose of this publication is to provide general information only. It does not contain an analysis of the law, nor does it constitute an opinion of Norton Rose on any point of law. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your usual contact at Norton Rose. No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose entity (whether or not such individual is described as a partner ) accepts or assumes responsibility, or has any liability, to any person in respect of this publication. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of, as the case may be, Norton Rose LLP or Norton Rose Australia or Norton Rose Canada LLP or Norton Rose South Africa (incorporated as Deneys Reitz Inc) or of one of their respective affiliates.