What is the Best Share Scheme for My Company? How to Reward Employees with Equity
Attracting, motivating and retaining great people often requires more than a competitive salary. Giving employees a stake in the company can be a powerful way to align everyone with the long-term success of your company.
However, offering shares or options can be complex. If the structure isn’t set up correctly, the tax consequences can quickly undermine the reward, turning what should be an incentive into an unexpected liability. Understanding the strengths and limitations of each type of scheme is essential if you want your company’s reward strategy to be both effective and tax-efficient.
One of the first questions most business owners ask is: which share or share-option scheme is right for my company? The answer will depend on a range of factors, including the size and stage of your business, the makeup of your team, your tax priorities and what you ultimately want the scheme to achieve, whether that is attracting new talent, retaining key individuals, encouraging growth or preparing for a future exit.
In this article, we break down the most common UK equity structures, helping you understand the benefits, drawbacks and suitability of each so you can make the right choice for your company. We will cover:
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- Enterprise Management Incentive (EMI) Options
- Company Share Option Plans (CSOPs)
- Growth Shares
- Unapproved Option Schemes
- Phantom Schemes
- Direct Share Subscriptions
Why Share Schemes Matter to Your Company
Share schemes can be one of the most effective ways to align your employees’ interests with the long-term success of your company. Instead of relying solely on salary or annual bonuses, your key people gain a genuine stake in the growth and value they help create.
A well-designed scheme can make it easier to attract and retain talented people, particularly in smaller or growing companies where cash flow may be limited. It can also help to encourage long-term commitment, as employees feel invested in the company’s performance and are motivated to contribute towards increasing its value.
The right structure will depend on your size, plans and priorities. Some schemes are designed to offer generous tax advantages, while others provide greater flexibility or are better suited to non-employees such as consultants or advisers. Certain schemes also work particularly well when you are planning for a future sale or exit.
Overview of Key Share Schemes
Scheme Key Benefit for You Tax Efficiency Company Suitability Key Drawback for You EMI Options Highly tax-efficient and flexible; strongly aligns employees with long-term growth and exit. Very high, no Income Tax or NIC on grant or exercise; Capital Gains Tax on sale, often eligible for Business Asset Disposal Relief. Small/medium companies within EMI qualifying thresholds. Strict eligibility and compliance rules; errors can invalidate tax advantages. Growth Shares Rewards only future value growth while protecting existing shareholder value. Good, profit on sale usually taxed as Capital Gains Tax. Companies with an established value and strong expectations of future growth. Higher upfront costs due to valuation and bespoke legal structuring. CSOP Tax-advantaged option scheme available when EMI is not. Good, no Income Tax or NIC if exercised after three years. Larger companies or those ineligible for EMI. £60,000 individual limit reduces award size. Unapproved Options Maximum flexibility; can include non-employees. Less favourable, Income Tax and NIC generally payable on exercise. Any company needing a flexible, low-administration solution. Potential tax burden on exercise; may require planning or gross-up. Phantom Schemes No dilution; simple administration and governance. Less favourable, treated as employment income (Income Tax and NIC). Companies wanting rewards without issuing shares or restructuring ownership. Employer and employee NIC costs can be significant. Direct Share Subscription Straightforward and transparent route to immediate ownership. Income Tax/NIC if shares issued below market value. Companies comfortable with employees becoming shareholders. Risk of ex-employees retaining shares without strong leaver provisions. Enterprise Management Incentive (EMI) Options
EMI options are a government-backed, tax-advantaged scheme designed specifically for UK companies. Under EMI, employees are granted the right to buy shares in the future at a fixed price, usually the market value at the time the options are granted. EMI offers your company a high degree of flexibility over when options vest (i.e. when an employee has earned the right to acquire the shares) and when they can exercise those options (i.e. when the options are converted into shares), whether that is based on time, performance or a future sale of the company.
Who Can Use EMI?
To qualify for EMI, your company must meet certain requirements. In particular, you must have fewer than 250 employees, less than £30 million in gross assets, and a permanent establishment in the UK. The company must not carry out excluded activities (e.g. financial services or property development), and the total value of unexercised EMI options across all employees must not exceed £3 million.
Employees must also meet specific criteria. They need to work at least 25 hours per week (or at least 75% of their working time), hold less than 30% of your company’s shares and must not hold more than £250,000 of unexercised EMI options over any three-year period.
How EMI Works
Once granted, the employee has the right (but not the obligation) to buy shares at the fixed price once their options have vested and any conditions have been met. Vesting can be based on time, performance, or an exit (i.e. a sale of the company), depending on what best aligns with your company’s objectives.
The primary advantage of EMI is the tax treatment of the options:
- on grant, there is no Income Tax or NIC for the employee;
- on exercise, there is no Income Tax or NIC for the employee (subject to compliance and valuation rules); and
- on sale, any gain over the exercise price is typically subject to Capital Gains Tax which can often qualify for Business Asset Disposal Relief.
When EMI is the Best Fit
EMI is often the ideal choice for small and medium-sized companies that meet the eligibility thresholds. It works particularly well if you want to attract, retain, and incentivise key employees by giving them a meaningful stake in the business. EMI is especially powerful for high-growth companies, allowing employees to benefit from future value increases in a highly tax-efficient way.
Company Share Option Plans (CSOP)
CSOPs are another form of tax-advantaged share option scheme. They can be particularly effective if your company is looking for a long-term incentive mechanism that offers flexibility while still operating within clear statutory rules. CSOPs are often used as a strong alternative where EMI options are not available.
How CSOPs Work
Under a CSOP, your company grants employees the option to acquire shares at a fixed price, typically the market value at the date the options are granted. The tax treatment is broadly similar to EMI:
- on grant, there is no Income Tax or NIC for the employee;
- on exercise, there is no Income Tax or NIC for the employee (provided that the options are not exercised within three years of being granted); and
- on sale, any gain over the exercise price is typically subject to Capital Gains Tax.
The key distinction from EMI is the value limit. Under a CSOP, each employee can only hold up to £60,000 worth of options (valued at the date of grant). While this cap is lower than EMI, it can still be used as a meaningful incentive for your employees.
When CSOPs are the Best Fit
A CSOP can be an appropriate alternative if your company does not qualify for EMI, whether due to size, group structure or the nature of your trade. It allows you to grant tax-advantaged options without many of the restrictions that apply to EMI, while still offering employees a valuable opportunity to share in the company’s future growth.
Growth Shares
Growth shares are a separate class of shares issued to employees or key individuals that only “participate” in the future growth of your company. Unlike ordinary shares, they do not benefit from the existing value of the business at the date of grant. Instead, the holder only benefits from the increase in your company’s value above a predetermined threshold/hurdle.
How Growth Shares Work
Growth shares allow your company to separate the current value (which remains with existing shareholders) from the new value generated by the people receiving the growth shares. For example, if your company is currently valued at £1 million and you set a hurdle of £2 million, the holders of growth shares will only benefit from the uplift above that hurdle. If the company is later sold for £5 million, they would participate in the £3 million of growth rather than the whole value.
Because growth shares only capture future value, their upfront cost is usually relatively low, making them accessible even to employees who may not be able to afford full-value shares. When the shares are eventually sold, the profit is normally taxed under Capital Gains Tax, which can be significantly more favourable than Income Tax, provided the hurdle has been met.
When Growth Shares are the Best Fit
Growth shares tend to be a strong option when you want to reward future performance and value creation without diluting the existing shareholders’ interest in the current value of the business. They are also useful when you need flexibility over who participates, as growth shares can be issued to non-employees such as consultants or advisers.
Unapproved Option Schemes
If your company or a particular individual does not qualify for a tax-advantaged scheme (or if you simply prefer not to use one) you can still grant options through an unapproved share option scheme. These schemes offer far greater flexibility but come with a less advantageous tax treatment.
The tax treatment for unapproved options differs significantly from the tax-advantaged schemes:
- on grant, there is no Income Tax or NIC for the individual;
- on exercise, Income Tax and NIC may be payable by the employee (on the difference between the market value at the date of exercise and the exercise price); and
- on sale, any gain over the exercise price may be subject to Capital Gains Tax.
When Unapproved Option Schemes are the Best Fit
Unapproved schemes can be highly effective when your company needs maximum flexibility. They allow you to include individuals who would not qualify for EMI or CSOPs, such as contractors, consultants or non-executive directors. They can also be used when you want to grant a larger value of options than the statutory caps permit.
These schemes are also appealing when you want to avoid the administrative requirements associated with tax-advantaged arrangements, such as formal valuations, HMRC notifications or ongoing compliance obligations.
Phantom Share Schemes
Phantom share schemes allow your company to reward employees for increases in company value, without issuing actual shares. Instead of becoming shareholders, the individuals receive a contractual right to a future cash payment that reflects the value (or increase in value) of the company’s shares.
When you should use Phantom Shares
A key benefit of a phantom share scheme is that it avoids diluting your company’s share capital. Your existing structure stays intact, and there’s no need to change your articles of association or shareholders’ agreement to accommodate new shareholders. This can be particularly attractive for owner-managed businesses who want the motivational benefits of equity rewards without giving away real equity.
Phantom schemes are also highly flexible. Like option schemes, you can set conditions that must be met before any payment is made, such as remaining with the company for a certain period, achieving performance targets or only paying out on an eventual sale of the company. You can also offer phantom shares to a wide range of people; they don’t need to be employees.
For some individuals, receiving a cash-based reward can be preferable to holding illiquid shares, especially if there is no immediate prospect of a sale. For example, a long-serving senior manager may value the certainty of a cash payout instead of waiting years for a potential exit.
Tax treatment of Phantom Shares
Any payments made under a phantom scheme are treated as employment income, meaning the individual will pay Income Tax and NICs on the amount they receive.
For your company, these payments are usually treated as a deductible expense for Corporation Tax purposes, although employer NICs may also apply.
Direct Share Subscription
A Direct Share Subscription is the simplest route if you want to directly give shares to your employee. Your employee buys newly issued shares for cash and becomes a shareholder immediately.
However, depending on your company’s value, it may not be easy for employees to afford the full market price of the shares. In these situations, there are two common approaches.
One option is for your company to loan the employee the amount they need under a formal loan agreement. The shares can be charged in the company’s favour until the loan is repaid, which often happens when the company is sold. It’s important that the interest rate is set correctly to avoid HMRC treating the arrangement as a benefit in kind, which could trigger an unwanted Income Tax charge.
Alternatively, your company might consider issuing the shares at a discount. The difficulty here is the tax treatment as the discount (the difference between the market value and the price actually paid) is treated as employment income. This means the employee could be subject to Income Tax and NICs before they have realised any value from the shares.
Another important point is that the individual becomes a shareholder immediately, so your company needs to ensure it has robust leaver provisions in place. For example, if the employee leaves the business, you will typically want the ability to require them to transfer their shares. This helps avoid situations where a disengaged or former employee remains as a shareholder, which can complicate future decisions or transactions.
Conclusion
Putting in place the right share scheme can be one of the most powerful levers for aligning your team with your company’s long-term success. The “best” scheme depends on your size, corporate structure, growth ambitions, cash flow, future investment plans, and what you want to motivate (e.g. retention, growth, performance, exit).
If you are considering implementing a share scheme to key employees, or if you are an employee who has been offered to participate in your company’s share scheme, please get in touch with our experienced solicitors in our corporate department. We usually offer a no-cost, no-obligation 20-minute introductory call as a starting point or, in some cases, if you would just like some initial advice and guidance, we will instead offer a one-hour fixed fee appointment (charged from £250 plus VAT depending on the complexity of the issues and seniority of the fee earner).
Please email wewillhelp@jonathanlea.net providing us with any relevant information ensuring that any call we have is as productive as possible or call us on 01444 708640. After this call, we can then email you a scope of work, fee estimate (or fixed fee quote if possible), and confirmation of any other points or information mentioned on the call.
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FAQs: What Are the Best Company Share Schemes?
Not necessarily. Many companies run share schemes and still raise SEIS or EIS investment without any difficulty. The important point is that the scheme must not give employees or option holders rights that clash with SEIS/EIS investor requirements. As long as your scheme is drafted with future fundraising in mind, there should be no interference. If investment is on the horizon, it’s sensible to check your share scheme early to make sure everything lines up properly before investors carry out their due diligence. The rules for tax-advantaged schemes are strict. If the eligibility conditions or valuation rules are breached, the tax advantages (for example reduced tax on exercise or CGT treatment on sale) may be lost. That can convert what was meant to be an attractive benefit into a costly liability. It’s therefore often worth getting professional advice to set up and administer these schemes. That depends on the terms of your scheme. Some share or option plans include “leaver provisions”, which are clauses requiring an ex-employee to transfer or forfeit their shares/options. If you don’t have robust leaver provisions, a former employee could remain a shareholder or beneficiary of options, which can complicate governance or future sales. Yes, but the ease of making changes depends on the type of scheme you are using. Some arrangements, like unapproved options or phantom schemes, are straightforward to amend. Tax-advantaged schemes such as EMI or CSOP have stricter rules, meaning certain changes could affect the tax treatment or require re-notification to HMRC. As your business grows, restructures or raises investment, it’s sensible to review your scheme to ensure it still meets your commercial goals and remains compliant.
- This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.