As an incentive that small to medium-sized companies can offer to key employees, EMI share options have proven to be very effective. They can be a tax-effective and mutually beneficial agreement between a company’s custodians (board of directors), owners (shareholders) and those key employees that add value to the business. With years of experience in dealing in the legal matters of businesses of all sizes, we are highlighting corporate processes that many of our clients over the years have used to their advantage to increase the value of their business and the value of their shares.
With our expert advice, you will be better equipped to avoid legal pitfalls and make the decisions that will benefit your business the most. In this first entry in our corporate advice series, we will be discussing enterprise management incentive (EMI) schemes.
An EMI share option plan enables persons granted share options with an opportunity to participate in the share ownership – or more typically, on the sale of the company’s issued shares. EMI share options are targeted at owner-managed-businesses (OMBs) and other small to medium enterprises (SMEs).
To qualify to grant EMI options, a company must:
Typically, EMI share options will be granted to employees who add real value to the business, and whose departure would hurt the company’s future.
The reason why existing shareholders may consider granting EMI share options depend from case to case, but include:
When a company’s Board of directors assesses that an EMI share option scheme may be of value both to the company and to the company’s existing shareholders, they will need to convene a meeting of all shareholders (or their representatives).
The granting of share options has the effect of “diluting” current shareholdings. To demonstrate by example…
To convince an existing shareholder to dilute his percentage shareholding, the Board will need a plan showing that either (i) failing to issue the option shares will have an adverse impact on the Company’s value; or (ii) that issuing the option shares is likely to materially increase the company’s value.
An EMI share option scheme is a tax-led procedure which must comply with current rules. The proposed option to be granted could be a one-off, or there could be an agreed scheme under which options are granted from time to time as determined by the trustees of that scheme.
The maximum value of qualifying EMI share options that may be given to any one employee is £250,000. Also, a company may not grant options worth more than £3 million in shares. Any options granted must be capable of being exercised within ten years of the date of grant.
The employee will be notified by the Board of their being granted an option, along with the applicable terms.
The option will (in nearly all cases) be a right to buy shares in the company at a value agreed by the Board with HMRC. That value will be heavily discounted against a comparable pro rata percentage of existing shares taken at commercial value.
Subject to the EMI scheme rules, the employee will become entitled to buy those option shares, but the purpose of establishing the EMI scheme may have included a planned exit/sale. This means that the option may become exercisable immediately before all other existing issued shares are sold; in such a case, the option holder exercises his right to buy the shares at the discounted price and immediately sell those option shares at the agreed overall share-sale price. The option-holder receives the profit, usually without having to fund the initial cost. The profit will then be subject to CGT.
If the employee leaves the company, the EMI rules may determine that the option lapses. The grant of a valuable share option is then considered a cost-free (to the company) method of retaining key employees and discouraging them from seeking new jobs.
A corporation tax deduction may be available when EMI options are exercised. The deduction is equal to the gains that the option holders have made. That has an advantageous impact on the company’s balance sheet.
The latent balance sheet benefit referred to above may result in the price-per-share increasing due to the uplift in balance-sheet value.
A HMRC-approved EMI share options scheme will avoid the risk of any options granted to employees being treated as “benefits in kind”. There is no tax liability on the grant of the option.
Providing the grant price of the option has been agreed with HMRC to be an accepted market value of that heavily discounted minority percentage shareholding, no tax will arise on the exercise of the grant.
On disposal, capital gains tax applies. Entrepreneurs’ Relief should be available provided the options were granted at least 12 months prior to the subsequent sale.
EMI share option schemes are an effective tool in the armoury of a Board who wishes to incentivise key employees. Should you have any further questions or require assistance with implementing EMI, our Corporate team are happy to receive your enquiry. If you would like an initial ‘no fee’ discussion with our experienced solicitors, contact the team directly:
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