Government stock option mess bears fruit for 'legal startups'

Lawyers said the government overreacted with its stock options laws in 2009, which have created a unique local market for creative tax structures.

The memory of the Australian government's stock options changes in 2009 still linger in the mind of a man who bemoans the change in policy, even though he has greatly benefited from it.

Wrapped up in a powder-blue double-breasted suit that disguises his entrepreneurial zeal, the loquacious tax lawyer David Kenney hosted me in the office of his firm, Hall Chadwick, which sits on level 29 of St Martins Tower, Sydney. It's a very corporate venue, which has gradually experienced the presence of an increasing number of very non-corporate entrepreneurs.

The heart of the Sydney CBD isn't a location that normally attracts the city's entrepreneurs, who are more at home in the fringe shelters of Ultimo, Surry Hills, or Redfern, but they are drawn to Kenney's unique service: Affordable tax advice on how to legally structure employee stock option plans (ESOP).

Their businesses span the seemingly endless breadth of technology markets, and have all matured to different ages in the startup lifecycle, but their founders are bound by a common desire to skirt the Australian legislation in order to share their growth with employees.

"Really, what [the ESOP] tries to do is maintain the most investor-friendly structure that permits the raising of capital, that permits access to any and all available government assistance, and provides asset protection," said Kenney, who has helped craft ESOP-lite plans for Australian startups such as and Shoes of Prey.

"It should be all about motivating employees — what it turns out to be is about jumping through hoops and trying to balance a lot of different, competing criteria, and you end up compromising on some things. You have to settle for best fit, rather than all-purpose solution."

Kenney is not the only one.

There are others just like him, a kinship that has established chapters around the country, including Andrew Andreyev's firm Andreyev Doman in Adelaide, and Gary Fitton's Remuneration Strategies Group in Melbourne.

These firms appeared, at first, in a sporadic frequency, but as the internet revolution sparked a plethora of startups with founders who yearned to share growth with employees, the tax firms settled into a comfortable, lucrative niche.

As they developed a cheap, efficient method to serve a new market segment neglected by incumbents, Kenney, Doman, and Fitton became a new breed of "legal startups" that advise their tech counterparts on how to navigate the undulating sea of red tape.

Essentially, their alchemy yields a version of the stock option, but does not offend the sensitive legislation. But this service doesn't come cheap.

These firms charge thousands of dollars for a custom-designed ESOP, which is much cheaper than the advice from the big four tax firms, which can go into the tens of thousands. These "legal startups" expect to make up the difference at the business end, such as an acquisition or initial public offering (IPO).

To structure a relatively inexpensive stock options plan upfront is simply a foundation for a lucrative relationship.

It's a virtue that was borne out of necessity — and commercial opportunity — rather than an altruistic service to the local community.

Tomorrow: Why ESOPs are important