The most popular share option plan for private companies in the UK is the Enterprise Management Incentives (EMI) plan. EMI is attractive because of its flexibility and significant tax advantages, including the 10% capital gains tax rate on the sale of shares.
This graph from www.gov.uk shows how popular EMI schemes are and that they’re on the increase.
Because they’re aimed largely at smaller, privately owned businesses, EMI schemes are simple and can be set up and run relatively cheaply and with minimal risk. This is particularly the case where options are granted over one class of shares, are exercisable on exit only, and they lapse when employees leave. However, sometimes companies want or need more complex plans, e.g.:
- options granted at less than market value;
- specific leaver provisions with director discretion for employees to keep the options or the shares;
- growth share plans, which can have ‘hurdles’ attached – e.g. the Company needs to achieve a certain value before option holders can share in any return;
- where bespoke performance conditions are required for individual participants.
It’s important to note that tailored arrangements like these will be more expensive and take longer to set up and manage as they need extra tax advice, amendments to constitutional documents, specific drafting, etc.
Most importantly they require an understanding not only of the EMI legislation, but also relevant HMRC guidance and best practice, which changes regularly without warning. If a plan is not set up or run properly it likely won’t give the intended benefits when needed. Even for a straightforward EMI, there can be areas which are easily overlooked.
This can have a number of negative outcomes, including loss of the beneficial tax treatment leading to unhappy and disincentivised employees when benefits are not delivered, the cost and time needed to fix it (assuming it is discovered and fixable), and problems when due diligence is being carried out for future funding rounds and/or an exit, which could include a price/value reduction.
Pitfalls can occur at any point during the lifecycle of an EMI scheme, for example:
- At the start you need to ensure the company and its employees qualify for EMI. There are specific rules relating to qualifying trades – even a very small percentage of income from certain activities may result in the company failing to qualify.
- Once options have been granted, they must be registered with HMRC within 92 days of the date of the option grant. If the deadline is missed the tax advantages will be lost. (This deadline will be removed for the 2024 tax year, but the EMI option plan will still need to be registered with HMRC.)
- Certain events can disqualify the plan or otherwise impact the EMI tax advantages, for example:
- a company that enters into a joint venture with another company is very likely to cease qualifying for EMI;
- an employee whose hours are reduced below 25 per week or who goes on sabbatical may no longer meet the ‘working time’ requirement for EMI.
In addition, we see other fairly common mistakes, such as incorrectly or partially completed documents, which can mean the option doesn’t even exist; or companies including non-employees in the scheme, which can have company law implications. These mistakes may look minor on the face of it, but can be expensive and time consuming to fix. So it would very likely be quicker and cheaper in the long run to hire a professional to set up and run the scheme than to try to DIY.
LegalEdge works with specialist share plans advisers like RM2 Partnership to deliver share plans that will deliver from implementation to exit. For more information or to chat through your options get in touch on email@example.com.