Stock options are viral ingredient needed to spark startup culture

In 2009, the Australian government's desperate tax grab furiously mangled the stock options in red tape, suffocated startups, and strangled the breathing room out of local entrepreneurship.

According to tax lawyer Andrew Andreyev, the restrictive regime blocked off pathways for Aussie startups that now emigrate overseas to more tax-friendly locations, such as San Jose, California, Menlo Park, California, New York, Singapore, and London.

"It's not just the brain drain; it's the enterprise drain," said Andreyev, who has worked in Australia and the UK, and has several clients in Silicon Valley.

"I always say we have a high dollar; high cost of labour; high property taxes; there's no cash in the banking system for startups; there's a thin or shallow private equity, VC, or angel pool in Australia. The one place left where you can get capital is people who believe in what you're doing, and you can't give them capital, because the system basically prevents it.

"It's like the last nail in the coffin for creating a culture."

Tax lawyers have attempted to salvage some good from the wreckage, but the imitation isn't as good as the real thing, according to Pollenizer's Mick Liubinskas.

The rules withhold the resources from the people who need it most: Entrepreneurs who need to hire new staff to transform a proven prototype into a sustainable business.

"The are two results," said Liubinskas. "Firstly, you don't get as much success. Secondly, you miss the success when entrepreneurs say, 'Ah, that's a bit hard, I'll just go set up a Delaware corporation — you won't miss me, but you also won't get my tax dollars when I employ 1,000 people'."

Starfish Investment principals Michael Panaccio and John Dyson sympathised with the US government's intention to crack down on executives who used the scheme to minimise their tax exposure, but in 2009 warned of the fallout for startups.

The fallout would include employees not being able to sell their shares at any time, because the companies are not listed; the prohibitive cost to hire third-party firms to value the shares; and the rules dropping Australia down the list of attractive places to do business.

Most importantly, high-risk businesses may fail, as they often do, which means that the employee would have paid tax on a worthless asset.

"For innovation to turn into commercialised ventures, it is imperative that governments, investors, and entrepreneurs work together as partners. We rely on each other to turn a great idea into a successful global business through policies that support innovation, capital injections to take these ideas to the marketplace, and outstanding individuals to execute the business plan and perfect the technologies," Panaccio and Dyson said (PDF).

"The proposed rules on taxation of employee share schemes will create a significant disincentive for individuals to be involved in an early-stage company, putting this delicate partnership at extreme risk.

"If there is no change to the employee share scheme provisions for startup, research and development, and speculative-type companies, it may result in high-quality entrepreneurs, academics, and technology experts staying in their current roles, and Australia losing out on creating new businesses and, more importantly, high-value jobs."

There is a simple solution for the government.

Starfish Ventures, one of the country's biggest investors in technology startups, proposed the creation of a separate regime for startups.

It could simply extend the highly praised R&D tax concession, which refunds 45 cents for every dollar spent risked and experimented on a new hypothesis, to companies with revenues of less than AU$5 million.

There are two key provisions: Tax shares if and when they generate a profit for the employee; and tax the shares as capital gains, not income.

The government ignored these requests.

The government just doesn't get it, Andreyev said.

"From a political perspective, the government believes there's two kinds of people: There's capitalist businesses, and employees. If you're a government, it's easier to deal with very big businesses and very small employees.

"People in between, who are creating new businesses, this quasi-employee/founder/entrepreneur, the government is very uncomfortable with those people."

Atlassian, the company that has borne the financial and regulatory burdens to offer stock options to employees, is the great white hope of Australian startups, according to Pollenizer's Liubinskas.

This is not because of the founders or the business model, but rather due to the brave first employees who will soon be rewarded for their gamble to shun the lure of big corporate dollars to invest their skills, time, and effort in Australia's most successful tech startup.

"What's really exciting about Atlassian's IPO [initial public offering] is not that Mike [Cannon-Brookes] and Scott [Farquhar] become wealthier, or Atlassian gets some credit, but maybe we'll create 10 millionaires in Australia who backed them early and worked their butts off; then they either leave and start startups, and start 10 more companies with the skills they've learned at Atlassian; and then those companies become successful; and then they create 10 more," said Liubinskas.

"In terms of real viral growth of startups, that's what gets me excited.

"If you don't have a simple options plan, you can't incentivise people in that way, so you don't bridge those generational gaps in the ecosystem."