The government’s changes to the Employee Share Scheme, introduced to parliament this week, mean from July 1 employee options won’t be taxed until they’re converted into shares.
Eligible startups – those with less than $50 million in turnover, aren’t listed on the stock exchange and are less than 10 years old – are able to issue options to employees at a small discount and defer tax for up to 15 years. The maximum individual ownership limit for accessing employee share scheme tax concessions will also be increased from 5% to 10%.
The setup for employee share options in Australia – where options were taxed in the year they were allocated – has long been a bugbear of the Australian startup sector. But they really only solve a small part of the puzzle.
The overall investment environment in Australia doesn’t give startups a fighting chance if they want to become a global company, competing with outfits emerging from China and the US where there are huge amounts of capital available to help scale businesses quickly.
Federal small business minister Bruce Billson said the changes are “unashamedly focused” on early stage startups. However, the changes only plug a very small part of a businesses’ growth journey.
Freelancer.com CEO Matt Barrie, whose tech company isn’t eligible for the ESS, says the ESS changes are “horribly constructed” and argues much wider reform is required to unlock the potential of high-growth, early stage companies in Australia.
Barrie told Business Insider the ESS legislation was “basically … just designed to placate the vocal early stage startup community, while doing nothing for the real Australian technology industry which actually provides the real employment and for whom stock and option grants will actually mean something.”
Barrie said companies financed by VCs, the ASX or private individuals “still lose” – especially with the turnover cap. Barrie estimated $50 million in turnover for a payments business is between $500,000 to $1 million in revenue a year.
“I see they have backed off on trying to double tax options as income tax instead of capital gains, but that’s only for companies that meet the <$50m turnover exemption. Everyone else they are screwing over with income tax when it used to be capital gains," Barrie said. "Strangely they have now provided Australian VC backed companies the exemption, probably because they have looked at the numbers and realise that Australian VCs - and particularly the three approved fund types (VCLP, ESVCLP or AFOF) don't actually fund many companies at all and that they have missed every single successful Australian tech company (unless you go back to Looksmart). "So the ESSs that get the VC exemption don't really matter anyway, it's a bone they can through at another vocal stakeholder to get them to keep quiet." With a number of early stage tech companies listing on the ASX surpassing those that are funded by VC, whether it be through the front or back door, Barrie said exempting listed companies from the scheme was "ridiculous". "ASX listed companies are still excluded which is ridiculous given that's where Australian technology companies now get financed - not by VCs. Companies financed by VCs - either Australian VCs that don't have those early stage funds (vclp,esvclp, afof - who has an Australian fund of fund of VCs?), overseas VCs, the ASX or private individuals - still lose. $50m in turnover for a payments business is around $500k - $1m in revenue per annum and a marketplace maybe $5m. The turnover exemption is just plain sloppy drafting. I could go on but I would be repeating myself," he said. Barrie's company listed on the ASX in late 2013. Scaling a tech company takes serious funding. Last year Campaign Monitor took on $US250 million in funding in a round led by Insight, this year cloud accounting firm Xero raised $US110 million in a round led by Accel. It’s those sort of deals that are required to fill the companies’ warchests and enable them to scale – and compete – with the deep pockets of international tech companies.
“The changes are still materially worse than how we used to tax employee share schemes, and much worse than the US, UK or Canada,” Barrie said.
In Australia, there is still a view that startups are just a few guys in a garage, rather than solid businesses that need more than 100 employees and significant turnover to make a return. Building a software company is also something that has many upfront costs: for many SAAS companies the cost of building out recurring revenue, developing a product and a customer base are mostly front-loaded and it can take years for the big profits to start flowing.
And technology companies need to be seen in the context of the global marketplace, where $50 million in turnover is tiny. Alibaba probably does that amount in a matter of minutes.
The latest legislation changes enable companies to reward their employees and attract talent but the obstacles to investors with serious capital and a healthy risk appetite haven’t been addressed.
“The government really doesn’t care about the technology industry, they have constructed this amendment to just shut up the most vocal sections of the community,” Barrie said.
It’s a concern given the tech sector has been heralded as one way to boost Australia’s competitiveness.