Guide
ESOP vs Phantom Shares (Australia)
Two ways to give your team equity-like upside in Australia — how each is taxed, what each costs, and when to pick one over the other.
The moment an Australian startup wants to give equity to its team, it hits a fork: ESOP (real options over real shares) or phantom shares (a cash bonus that behaves like equity). Each has real tax, legal and cultural consequences. Choose deliberately.
How Each Works
ESOP (Employee Share Option Plan): the company grants options — the right to buy shares at a fixed exercise price at some future date. Options usually vest over 4 years with a 1-year cliff, mirroring founder vesting. On exercise, the employee pays the exercise price and becomes a shareholder.
Phantom shares (also called "shadow equity" or "share appreciation rights"): the company grants "phantom units" that track the value of a share. There is no exercise price and no share ever issued. On a trigger event — usually a sale or IPO — the employee receives cash equal to (current share value − starting share value) × units held.
The Big Comparison
| Feature | ESOP (Options) | Phantom Shares |
|---|---|---|
| Employee becomes shareholder | Yes, on exercise | No — ever |
| Cap table impact | Dilutes at exercise | None |
| Voting rights | Yes, once shares issued | None |
| Tax on grant | Usually none (Startup Concession) | None |
| Tax on exit | CGT (potentially 50% discount) | Ordinary income (up to 47%) |
| Company cash outflow | None — employee pays exercise price | Real cash payment at trigger |
| Suitable for offshore team | Complex — foreign tax, securities law | Simple — just a contract |
| Setup cost | $4,000–$8,000 + GST | $2,000–$4,000 + GST |
| Ongoing complexity | ESS reporting to ATO annually | Low — payroll tax treatment |
The Australian ESOP Tax Advantage
Australia has one of the world's better startup ESOP regimes. If your company meets the Startup Concession criteria — under 10 years old, unlisted, aggregated turnover under $50m, incorporated in Australia — options can be granted with:
- No tax on grant
- No tax on vesting
- No tax on exercise
- CGT only on sale, with 50% discount if held over 12 months
This is genuinely tax-efficient equity — much better than the phantom equivalent, which is taxed like a cash bonus at marginal rates. See our dedicated ESOP guide.
When Phantom Shares Are the Right Call
Despite the tax disadvantage, there are situations where phantom shares are clearly better:
- Offshore team members — securities law in the employee's country may make issuing options impractical
- Contractors — the Startup Concession only applies to genuine employees
- Advisors where a small equity-like incentive is wanted without cap table complexity
- Family businesses that want to reward key staff without making them shareholders
- Companies past the Startup Concession window — once you are over $50m turnover or 10 years old, ESOP loses much of its tax benefit
The Case for ESOP by Default
For any Australian startup under the Startup Concession thresholds, ESOP is the default answer for permanent employees. Three reasons:
- Tax — the concession is a genuine gift; do not leave it on the table
- Alignment — being a shareholder is culturally different to being a bonus recipient
- Investor expectation — every institutional investor expects an ESOP pool of 10–15% at seed / Series A
The ESOP Pool
Institutional investors will require an unallocated pool of options — typically 10% at seed, 15% at Series A. The pool is usually created out of the founders' equity before the round closes, so the dilution hits founders, not investors. Model this before you sign the term sheet.
Common Mistakes
- Granting phantom shares because "it is simpler" — often true short-term, but you have committed the company to a real cash payment at exit
- Setting exercise price too low — can void the Startup Concession; needs a defensible valuation
- No vesting on advisor grants — advisor leaves after 6 months, keeps all shares
- Forgetting to lodge annual ESS statement with ATO — required for every year options are on issue
Frequently Asked Questions
What is the main difference between ESOP and phantom shares?
An ESOP gives employees actual options over real shares in the company — on exercise, they become shareholders. A phantom share scheme gives employees a contractual right to a cash payment equal to the value of a share, without ever making them a shareholder.
Are phantom shares taxed the same as options in Australia?
No. Phantom shares are almost always taxed as ordinary income (like a bonus) at the time of payment. ESOP options in a qualifying startup can access the Startup Concession, deferring tax until sale and taxing gains at CGT rates — often much lower.
Do phantom shares dilute my cap table?
No — that is the main appeal. No shares are ever issued, so the cap table is untouched. But the company has a real cash liability when the phantom units are 'cashed out', usually on a liquidity event.
Can a startup use both?
Yes, and it is fairly common. ESOP for permanent employees you want as shareholders; phantom shares for contractors, offshore team members, or advisors where actual share issuance is complex.
Next Step
See our detailed ESOP guide, our startup packages, or book a 15-minute call to plan your equity scheme.
Talk to us
Ready to talk it through?
Send us a note about what you're working on. We'll respond within one business day and, if we're a fit, book a free 15-minute consultation with a senior lawyer.