A Guide to Incentivisation Through EMI Options and Growth Shares
Incentivising and retaining key employees effectively is a strategic objective that many companies prioritise to ensure that the growth objectives of the company are aligned with employee goals.
Popular choices for business owners are either to grant EMI options over ordinary shares in the business or to issue employees with a special class of growth shares. Recent circumstances surrounding the COVID-19 pandemic have led to businesses reconsidering standard pay packages (including cash bonuses) and focussing on preserving cash balances by using tax efficient share-based structures instead.
The recent economic outlook provides an opportune time to agree low or nominal valuations with HMRC for the issue of EMI option shares which improves the efficiency of these schemes, thereby reducing the level of existing shareholder dilution required.
EMI option schemes involve the grant of options to acquire shares, usually on a specified future event (for example the sale of the business). Until the option is exercised, the employee is not a shareholder and cannot for example benefit from dividends.
Qualifying companies* can set up an EMI scheme, allowing them to grant EMI options to qualifying employees over shares in the company, thus enabling the employees to receive a share in the capital value of the company upon an exit event.
- Qualifying employees*:
- Employees must be required to work for at least 25 hours a week, or, if less, at least 75% of their working time must be spent working for the company.
- Employees must not have a ‘material interest’ of more than 30% of the share capital before the options are granted.
*Please be aware that these are not the only provisions outlined in the legislation. Further requirements apply to qualifying companies, and you should seek professional advice before implementing an EMI scheme.
Benefits of an EMI scheme include:
- Usually no National Insurance Contributions.
- Corporation tax relief on the difference between the market value when the shares are exercised, and the option price agreed when they were initially granted.
- Valuation usually agreed with HMRC prior to grant.
- EMI options automatically qualify for Business Asset Disposal Relief (formally Entrepreneurs’ Relief) after a two-year holding period.
Growth shares allow employees to become shareholders immediately on terms which can be tailored by the company (for example the right to capital, dividend and voting rights can be tailored, as well as the imposition of certain ‘hurdles’ or ‘ratchets’ that need to be met) to provide an effective incentive to grow the business’ value and share in the capital value achieved once the exit value of the company hits a pre-determined ‘threshold’ or ‘hurdle’.
For EMI share options HMRC will agree in advance the valuation to be ascribed to the share options on issue.
However, HMRC do not provide advance agreement to valuations of growth shares, increasing the possibility of unforeseen tax liabilities arising.
Growth shares also have the following disadvantages:
- There will be an income tax liability on the difference in value between the price paid for the shares and the market value on eventual sale of the shares.
- A new class of share needs to be created.
Because of the extra complications relating to growth shares, EMI schemes are often preferred ahead of growth shares unless the company does not meet the EMI eligibility criteria.
Tailoring EMI options to introduce growth requirements
An EMI share option award can also incorporate performance targets and other considerations.
EMI qualifying share options can be awarded over a new class of shares, which might have certain terms attached to them relating to performance objectives etc. in a similar way to how terms are applied to growth shares.
This allows a business to combine elements of both arrangements.
We are able to aid you with the implementation of either an EMI option scheme or a growth share scheme, and can provide assistance in:
- designing the scheme;
- structuring the share rights;
- valuation analysis/HMRC agreement;
- tax analysis; and
- helping you implement the scheme and meet your ongoing HMRC notification obligations.