How to set up an EMI option scheme
People can make or break your business — so the importance of having the right people and retaining talent usually comes back to one thing — incentivisation. The word “incentive” can raise alarm bells for early stage businesses, as you simply don’t have the financial resources to pay competitive salaries and bonuses. However there are alternatives — one of which is an EMI “Enterprise Management Incentive” option scheme — so this could be just what you’re looking for!
So how does an EMI option scheme work?
Assuming that your business passes the relevant eligibility tests — then you can offer (or “grant”) selected employees the right to purchase shares in the company at an agreed price, upon a certain “trigger event” occurring. Once the trigger event occurs, the employee is entitled to “exercise” their share options and acquire the shares at the pre-agreed price.
What is a trigger event?
A usual trigger event is the sale of the company, which would allow the employee to exercise their options and sell the shares as part of the overall transaction.
Other triggers can include the following:
- the employee reaching a certain length of service with the company;
- the achievement of certain performance targets by the employee holding an option; or
- the company achieving a particular market capital valuation.
What are the benefits of an EMI option scheme?
- Committed to the growth of your business — it’s no secret that employee share option schemes have historically been a useful means of incentivising staff. Rather than simply taking home a regular salary each month as compensation for their work, share options give employees a vested interest in the growth and success of the company by having the opportunity to obtain equity in the business they work for.
- Tax benefits for you and your employee — the added value of an EMI scheme, in comparison to a regular share option scheme, is that there are a number of tax benefits which apply, both for the option holder and the business
- Employee tax benefits:
- Upon grant of the option, there is no immediate charge to the employee’s income, therefore there is no up front tax liability.
- Upon exercise of the option, assuming that the pre-determined price of the shares is equal to the market value of the shares as at the date of exercise, then no tax will be payable on acquisition.
- Upon sale of the shares, the lower rates of capital gains tax will apply (as opposed to the higher rates of income tax) on any profit between the pre-agreed option price and the sale price. The level of tax payable will vary depending on when the options were granted.
- Tax benefits for your business:
- The cost of setting up and administering the EMI scheme is classed as an allowable expense of the business and therefore corporation tax relief will be available.
There is a limit ! — the aggregate total pre-determined value for all the shares to be offered under an EMI scheme cannot exceed £3 million. Individually, the pre-determined value of an employee’s share options cannot exceed £250,000 over the course of a 3 year period from the date on which the options are granted to them.
Any options granted under an EMI scheme must also be capable of being exercised within 10 years of the date of their grant.
How to set up an EMI scheme? The initial basic steps are:
- Check eligibility — ensure that your business is eligible to set up an EMI scheme (you can also seek “advance assurance” from HMRC to confirm that the company qualifies. This is not mandatory, however if time is not of the essence, then it is recommended that such assurance is obtained as a means of rubber stamping the scheme, particularly to ensure HMRC agrees that the scheme is motivated by genuine commercial reasons, rather than purely for the purposes of tax avoidance). There are a number of requirements your business and selected employees need to satisfy in order to qualify for an EMI option scheme, including the “gross assets test” which requires a company to have a gross assets value of no more than £30 million as at the date of the option being granted and the “working time requirement” for employees, which requires an employee to devote no less than an average of at least 25 hours a week working for the business.
- Obtain an initial market valuation of the company’s shares — this helps to ascertain the price of the option shares to be paid by the employees when they come to purchase the option shares. This valuation can also be shared with HMRC prior to the granting of the options themselves. Again, this is not strictly necessary, but it is advisable.
- Rules and regulations — draw up the share option scheme rules and regulations as applicable to your business.
- Document it — arrange for the option documentation to be drawn up.
- Follow the right procedural steps — once the documentation has been drawn up, other procedural steps need to be taken before the options can be granted.
So, we’ve outlined the basics for EMI schemes as a useful tool to incentivise your employees and encouraging organic value growth within your business. Whilst there are some costs to implementing a scheme and drawing up the documentation, this is likely to be a small price to pay compared to the costs attributed to departing employees, both in terms of direct monetary costs and the possible disruption to the business.
Generally, the process for setting up an EMI option scheme is relatively straightforward, however we would stress that you should always seek guidance and support from professional advisors beforehand.
Please contact the Trowers team for more information. We have also produced a series of fact sheets to help you, so click here to access our online resources.