Founders usually come to us asking what number to put on their shares for an employee share scheme. It is the right question – but it is the second one. Before the number matters, you need to know whether you qualify for the startup tax concession at all, because that concession is the entire reason an ESOP is worth offering. So let’s start there, then get to the valuation.

First, do you qualify as a “startup”?

The startup concession is what makes employee options attractive in Australia. Under it, your team is taxed only when they eventually sell their shares – under the capital gains rules, with the 50 per cent discount if they have held long enough – rather than being taxed at grant or exercise on paper gains they cannot yet spend. That is the deal you are trying to give your people, and it only works if your company meets the concession conditions at the time you grant. The headline ones:

• Your company is less than 10 years old, measured across your whole group from incorporation. This is the “10-year rule”.
• Aggregated group turnover under $50 million for the prior income year.
• The company is not listed on a stock exchange.
• The employing company is an Australian resident.
• The options or shares are over ordinary shares and meet the market-value conditions below.
• No employee holds more than 10 per cent of the company, or more than 10 per cent of the voting rights. This one quietly catches co-founders, so check it before you grant to anyone already on the cap table.

What if you are over 10 years old, or over $50 million?

You can still run an ESOP – you just cannot use the startup concession, so the tax outcome for your team is different. Grants generally fall under the ordinary employee share scheme rules, where tax is deferred to a later taxing point rather than pushed all the way out to sale under CGT. That changes the maths for your people, and sometimes the case for using options at all. If you are near or past the 10-year mark, it is worth a proper look at whether an ESOP is still the right mechanism. Either way, you still need a defensible market value, so the methods below still apply.

Why the valuation matters

Assuming you qualify, the valuation feeds one of two tests, depending on what you issue:

• For options, the exercise price must be at least equal to the market value of the underlying ordinary shares when the option is granted. Set it too low and the option falls outside the concession.
• For shares issued directly, the discount to market value cannot exceed 15 per cent at the time they are acquired.

One thing to be clear on: this is not your raise valuation. Your raise number is a forward-looking negotiation built on traction and story. Your ESOP valuation is a defensible market value of your ordinary shares today, and it is almost always lower. That is a good thing – a low, well-supported number means a low exercise price, more upside for your team, and it keeps the options inside the concession.

The two approved methods

The ATO gives you two safe-harbour methods. Use one correctly and the ATO is bound to accept your valuation, which is the whole point. We will take them in the order most founders actually use them – net tangible assets first. Worth noting: the ATO labels net tangible assets “Method Two” and the comprehensive approach “Method One”. For an early-stage startup issuing its first options, net tangible assets is almost always the cleanest starting point.

Net tangible assets (the ATO’s Method Two)

This is the balance-sheet method. You take your net tangible assets, deduct the amount that would be owed on any preference shares if they were paid out ahead of ordinary shareholders (typically your investors’ liquidation preference), and divide what is left by the number of ordinary shares plus any participating preference shares on issue. That gives you a value per ordinary share.

You can only use it if your company meets all three of these:

• You have not raised more than $10 million in capital, debt or equity in the 12 months before the valuation.
• At the valuation date you have been incorporated for not more than 7 years, or you are a small business entity.
• You have prepared, or will prepare, a financial report for the year the valuation falls in.

This is where two numbers get tangled, so separate them clearly. The 10-year test earlier is about whether you are a startup at all for the concession. The 7-year test here is only about whether you can use this simplified net tangible assets shortcut. Different tests, different jobs. You can be, say, 8 years old, fail the 7-year shortcut, and still be a perfectly good startup using the comprehensive method.

And even past 7 years you can still use net tangible assets if you are a small business entity – broadly, carrying on a business with aggregated turnover under $10 million. So the practical question at the 7-year mark is not “can I still do an ESOP” but “which valuation method do I use”.

The comprehensive method (the ATO’s Method One)

Here your CFO, or a suitably qualified valuer, works out market value on the fuller picture: tangible and intangible assets, comparable businesses and earnings multiples, uplifts and discounts for control, lack of marketability and key-person risk, and the present value of future cash flows. Your directors then endorse both the method and the value by written resolution.

This is the route when your balance sheet does not tell the real story – common once you have meaningful revenue, real intangible value, or you have raised past the net tangible assets thresholds.

When to redo your valuation

A valuation is a snapshot, and options are priced at whatever the value is on the day you grant. As new people join in later rounds, you set their exercise price on a fresh valuation, so this is not a set-and-forget number. Refresh it whenever the market value has moved, or whenever the balance sheet has changed materially if you are using net tangible assets. In practice: after a funding round, after a material change in the business, or whenever the number is simply getting stale. As a rule of thumb, look at it again at least every 12 months.

The bottom line

Qualify first, value second. Check you are inside the startup concession, watch the 10 per cent co-founder trap, and do not confuse the 10-year concession test with the 7-year net tangible assets shortcut. For most early companies, net tangible assets is the cleanest place to start, moving to the comprehensive method as you grow or your balance sheet stops reflecting real value. Keep your ESOP valuation separate from your raise number, and revisit it at least once a year.

Disclaimer: This article is for general informational purposes only and does not constitute financial, legal or tax advice. Please speak with a qualified adviser (hey, that’s us!) before making decisions based on your specific circumstances.