Employee share schemes are increasingly common and increasingly seen as a cost-effective incentive for rapidly growing businesses in a range of sectors. We have recently seen some of the early schemes we helped to implement now come to fruition, which has been hugely satisfying.
So why have employee share schemes become so common? We believe it is down to a combination of a change in attitudes toward employees owning a piece of the pie in recognition of their hard work, as well as an appreciation of the flexibility and incentive offered by the arrangements. One of the most common employee share scheme is the Enterprise Management Incentive scheme (EMI), which we aim to outline in this article.
An EMI scheme
An EMI scheme enables options to be given to employees to acquire shares in a company upon various events happening. In this sense, it is no different to an option to acquire property or some other asset. The price for the shares is set on the date of grant and is usually the market value of the shares on that date, or higher. Importantly this purchase price is not payable until the EMI option is actually exercised and nothing needs to be paid on the date of grant! There are certain restrictions that apply to EMI options, caps as to the value of the options and notably the EMI options can only be granted to employees of the company. However, broadly speaking many businesses would qualify to grant them.
Usually the employee being able to exercise the EMI option will be dependent either on the employee hitting certain performance criteria over a period of time, or on the employee being employed by the company when it is sold. Giving an employee the right to share in the benefits of the sale may well bridge the gap between a salary paid by a well established competitor versus that able to be paid by a start-up business.
Why is the EMI scheme so flexible? Doesn’t that mean the employees holds shares and I need to consult with them on shareholder matters? No! An EMI option is only an option to acquire shares upon certain events happening. It doesn’t necessarily give the employee the right to acquire shares at any time, or upon an event of their own choosing. The company can maintain complete control if it needs to. For example, the EMI option may be dependent on a sale of the company occurring. That being the case, the employee would only be able to acquire the shares when there was certainty of a sale.
In practice the employee would only exercise the EMI option and then be issued shares moments before the company is bought. The shortest shareholding in history! You can issue the shares under EMI options prior to a sale if you wish and then the employee will be a shareholder, probably requiring you to consult with them on certain decisions. In this event we would also recommend a bespoke Shareholders Agreement, as well as appropriate Articles of Association to regulate the shareholder relationship.
If an employee leaves having been granted EMI options, the options can simply lapse with no need to arrange any transfers of shares, which would otherwise have been the case.
Tax benefits you say? If EMI options are granted on the basis that upon exercise the employee pays market value of the shares (being market value on the date of grant), then the tax on all of the increase in value falls within the capital gains regime and not employee taxes. Once more, the employee may be able to claim entrepreneur’s relief regardless as to the size of the shareholding.
It is advisable to get an accountant to prepare a valuation of the shares which is agreed with HMRC, prior to the grant of the EMI options. Usually the values accepted by HMRC are heavily discounted, meaning that the employees can get shares at low values, maximising the increase in value received.
Our view is that EMI options allow companies to grant important employees a tax efficient incentive, which is flexible, promotes growth and brings people together to achieve a common goal. We happily recommend them to clients.