Our Top 5 Recommendations For EMI Share Option Schemes
Top 5 Tips for EMI Options
1) Separate generic scheme rules (that apply to everyone, e.g. when options lapse on leaving the company before options vested) and then bespoke option certificates that include details specific to each option holder such as exercise conditions (for example every year of employment or with reference to company turnover target or individual metrics such as sales targets).
2) Agree a low valuation with HMRC. Irrespective of the valuation you may have achieved by raising money. Without an agreed HMRC valuation, a company is likely to have its historic market values questioned meaning there will be a risk that the options were granted at a discount or that the EMI limits were exceeded at grant. We have seen a few startups do their own valuation that is based on a recent investment round they’ve carried out. This results in an unnecessarily high value being used for setting the option price and reporting those values to HMRC. Regardless of what value they raised money at, the same companies could have agreed a lower valuation with HMRC and therefore significantly lowered the buy in costs for employees and/or tax liabilities on exercise.
3) Non-voting alphabet shares. HMRC agreed a valuation relating to options granted in respect of B shares to be issued once the option is exercised. The company’s articles defined the B shares as alphabet shares whereby the board could declare a dividend that was distributed in non pro-rata proportions between A and B shares, while the B shares were non-voting but otherwise had an equal right to any capital distribution made to shareholders. Therefore, because there is no fixed rate to dividends the B shares for the purposes of the EMI share option scheme can be considered ‘ordinary share capital’.
Please also note that a separate class of shares that are non-voting and/or carry no rights to dividends can also be considered qualifying ‘ordinary shares’ for the purpose of the EMI share option scheme.
4) Guidance letters. Both for employer and employee describing the process of granting and exercising the options, explaining the key terms and clearly outlining the tax implications.
5) Exercise before 10 years if no exit event. One of the main qualifying conditions is that the options must be capable of exercise before the 10 year anniversary of grant. Therefore to prevent the danger that the employee has to exercise outside of the 10 year limit and thereby incur an income tax liability on exercise a clause is often inserted in the EMI share option documentation that states if no exit event has occurred, or looks like it will occur, before the end of this 10 year period then the company and / or founding shareholders will allow the option holder to exercise before the end of the 10 year period and in return their shares will be purchased for a material sum. This therefore allows the employee to make a decent capital gain while avoiding the potential downside of continuing to hold options which have lost their EMI beneficial tax status.