Last updated on September 12th, 2022 at 11:38 am
Since its launch in 2000, implementing an Enterprise Management Incentive (“EMI”) share option scheme has become by far and away the most popular HMRC tax favoured share incentive plan adopted by companies for UK employees.
Essentially, qualifying companies can set up an EMI scheme whereby options can be granted over shares to qualifying employees worth up to £250,000 (per employee) without giving rise to an income tax or National Insurance Contribution (“NIC”) charge. They also allow the employee to purchase shares in the company for a discounted value. The total value of shares in a company which may be subject to unexercised EMI options at any one time is £3 million.
EMI option schemes are intended to help companies retain valued/key employees and to incentivise/reward such employees for investing their time and skills in helping the company grow.
Particularly for tech start-ups, share options can be an important part of the package in attracting high calibre employees who can be persuaded to join a company for a lower cash salary when they see the potential for realising a significant capital gain in the future (on an exit event when their options will commonly be exercised).
Share options more closely align the interests of a company’s owners and its employees as both will be more united in wanting to build long-term shareholder value through growing the business in the expectation that everyone will eventually benefit from an exit event.
Briefly, EMI options have two key tax benefits, these being that:
- No income tax is usually charged upon exercise of the option; and
- Capital gains tax (“CGT”) upon eventual sale of shares acquired on exercise of an option is usually charged at a reduced rate of 10%.
There are various ways that EMI share option schemes can be structured, which are (generally) as follows:
- on an ‘exit only’ basis;
- on a ‘time only’ basis; or
- on a ‘time and performance’ basis.
EMI schemes structured on an exit only basis are what we most commonly encounter, given that structuring the scheme in this way means that the option holder(s) will not be able to exercise their option(s) until an exit event occurs. An ‘Exit’ event usually encompasses a share sale, an asset sale, a successful application and admission of all or any of the shares in the capital of the company to the Official List of the UK Listing Authority or the AIM market operated by the London Stock Exchange plc, or the Nasdaq National Stock Market of the Nasdaq Stock Market Inc (referred to as a “Listing”) or a capital raising which the board of the company determines should be treated as an exit event.
If an EMI scheme is structured on a time only basis, this means that as soon as the shares become vested (which will be in accordance with a vesting schedule so as to incentivise the employee to remain in employment with the company for a set period of time), the option holder(s) will be able to exercise their option(s).
If an EMI scheme is structured on a time and performance basis, this means that the options will vest in accordance with a vesting schedule, but the option(s) will not be capable of exercise by the option holder(s) until certain exercise conditions are met. Exercise conditions could be performance-based, such as the company’s turnover or EBITDA being more than a certain amount for a given period of time. Alternatively, the exercise of the option could be linked to individual sales targets. Both of these are common exercise conditions given that they are objective and easily quantifiable metrics.
In this case, the client made contact via our website having read our detailed blog post on EMI share option schemes.
In accordance with our usual policy, we hosted a 20-minute no cost, no obligation call with the client so that we could better understand how they intended for the EMI scheme to be structured and their specific requirements. Following the call, we sent the client a comprehensive email detailing our quote for the work and explaining how we operate in relation to such matters.
The client in this case was operating an established software development company and was seeking to implement the EMI share option scheme so as to incentivise and retain two key employees.
The plan was structured on a time and performance basis, with some options over shares being capable of exercise immediately, with the option holders then having the opportunity to acquire further options over shares if they had continuous employment with the company from the date of grant until a defined future date. The option holders could then exercise these further options held over the additional shares once they had met individual performance targets.
Although there were conditions attached to the exercise of the additional shares (in the form of individual performance targets), the client wanted the scheme to be structured so that the company’s board retained the discretion to allow the option holders to exercise their options in respect of the further shares even in circumstances where the option holders failed to meet any or all of the prescribed exercise conditions. This added a layer of complexity that would otherwise not have been present, and required the documentation to be drafted carefully and accurately.
We assist with advising on and implementing EMI share option schemes in collaboration with an accountancy firm that has solid experience in agreeing low valuations with HMRC (which is a necessary part of the process when implementing such schemes).
Our preferred accountancy practice charges £1,500 plus VAT (£1,800) to carry out the tax and valuation work, which primarily consists of:
- Completing the HMRC share valuation application which includes requesting and studying information supplied by the client, carrying out the valuation (in order to determine the exercise price of the share options), writing a letter to HMRC requesting agreement to the proposed share valuation, compiling supporting documentation and engaging in any dialogue or negotiation with HMRC if required.
- Once the share option scheme contractual documentation has been agreed and signed, the accountancy practice will then carefully complete and submit the formal notice of the grant of the EMI options to HMRC.
In this case, HMRC accepted the accountant’s proposed valuation which was set at £0.01 per ordinary share for the purposes of granting EMI options under the proposed scheme.
HMRC’s approved valuation remains valid for a period of 90 days from the date of their acceptance letter and therefore it is vital that the legal documentation governing the EMI scheme is drafted, agreed and finalised, and the options granted, within that 90-day period. From the date of grant, the company then has 92 days from that date in which to register the grant of options with HMRC.
How we helped/what we did
Our remit in relation to EMI share option schemes involves advising on and producing the contractual and legal documentation, and we charge a capped fixed fee £1,500 plus VAT (£1,800) for this work.
Whilst the accountancy practice was conducting the valuation aspect, so as to ensure that everything was completed within HMRC’s time limits, we sent the client our EMI option scheme checklist and questionnaire (which can be downloaded free from our website here under the “Free checklist” subheading).
The reason why we circulate the checklist/questionnaire for clients to complete is so that we can better understand how they envisage the EMI scheme being structured and to confirm any particular requirements they wish for it to contain. This ensures that we can be sure that we put in place well-considered and bespoke legal/contractual documentation to govern the client’s scheme.
Once the client had completed and returned the completed questionnaire to us, we hosted a call with the client to go through the questionnaire step-by-step to clarify any ambiguities and answer the client’s questions. We then confirmed our discussions with the client via email and began drafting the EMI scheme documentation.
In this case, we assisted the client by producing and advising on the following documents:
- Advising on and putting together EMI option agreement documentation (in the form of separate, detailed scheme rules and a bespoke option certificate document for each option holder that included terms specific relating to each of their options);
- Reviewing the company’s existing articles of association and producing a “cover page” (essentially a set of new articles) to govern the company’s existing articles. The new articles provided that if the employee/option holder were to leave employment with the company then any shares issued to them at that point pursuant to the successful exercise of options would be subject to a re-purchase right in favour of the company. The new articles then set out at what price the shares would be re-purchased and this depended on whether the employee/option holder was determined to be a ‘good’ or a ‘bad’ leaver at the discretion of the company’s board. We also produced relevant board minutes and a written shareholder resolution in respect of the adoption of the new articles by the Company.
- Detailed guideline documents for both the client as employer and also the employee, describing the process of granting and exercising the options, explaining the key terms and clearly outlining the tax implications.
- Written shareholder resolutions and board minutes approving the terms and implementation of the EMI option scheme and the grant of EMI options.
The EMI plan/scheme rules in this instance had to be particularly detailed, given that the client wanted for the initial part of the option to vest and be capable of exercise immediately on the date of grant, with other parts of the option vesting in accordance with a vesting schedule. The other parts of the option could then only be exercised once the option holder met performance targets as set out in their respective option certificates, although (as described above), the company’s board had the discretion to allow option holders to exercise their options even under circumstances where some or all of the exercise conditions had not been met.
Once all of the documents had been produced, we sent them all over to the client along with a detailed explanatory covering email, setting out what the client needed to do in respect of each document.
We ensured that the client was kept up-to-date with the progress of the documents throughout the process, and that all documents were explained clearly (which is essential given the complexity of EMI share option schemes). Our tried and tested process for advising on and implementing EMI option schemes means that we can advise the client in a time efficient manner and ensure that everything is completed within the various HMRC deadlines.
The outcome in this case was that we helped the client put into place a legally binding, well-considered and bespoke EMI share option scheme under which it could issue EMI qualifying options to key employees in order to incentivise them to remain with their company and help it grow and develop over the long-term.