EMI Options Scheme
Today, we’re going to be explaining an accounting strategy that can be implemented to encourage sought-after employees to join your startup, rather than a large corporation – that perhaps offers a higher salary!
Enter – the Enterprise Management Incentive.
The Enterprise Management Incentive (EMI) is a tax-advantaged share option scheme designed for smaller companies.
The EMI is a share option scheme that enables companies to attract and retain key staff by rewarding them with equity participation in the business.
The scheme is fantastic for early-stage companies that might not be able to match the salaries paid elsewhere.
What Are EMI Schemes and EMI Share Options?
Simply put, a share option presents the right to acquire shares in a company, on terms set out in an option agreement.
The option agreement will specify the proportion of shares an employee may acquire, how much they will have to pay for these shares, and when the shares can be acquired through exercise of the option.
For example, option exercise may occur after a specified period of employment, upon the achievement of previously outlined KPIs, or upon sale of the company.
Why do businesses implement EMI Schemes?
From working with startups, we know that early-stage founders must be conscious of spending.
In these situations, shares or share options can be a key component of the employment package in attracting a high-quality team.
A prospective employee that sees potential in the growth of the business may see significant value in receiving a significant lump sum through the sale of shares.
In turn, this may incentivise them to join your company, even if the annual salary is less than what a larger company may offer.
Simultaneously, integrating the EMI Scheme into your employment contracts can allow you to build a scalable team that has a vested interest in the overall success of your business.
Should Employees Have EMI Share Options or Shares?
The answer to this isn’t black and white.
In some cases, it will make sense for employees to have shares from the outset. However, this will generally involve employees having to pay for their shares, or suffering a tax charge if their shares are gifted or bought at less than full value.
Having share options can be more beneficial for the employee than having shares, if the share options are only exercisable upon achievement of targets.
It’s worth noting that many companies prefer employees not to have shares from the outset, because of complications that would arise if they resign.
So, typically, the preferred method is to issue share options rather than upfront shares.
How Are EMI Share Options Taxed?
Good news – the share options are granted come without a tax charge!
However, for an “unapproved” share option, such as an option without the special tax benefits of EMI or other approved share plans, income tax and National Insurance can be charged.
And when the shares are sold, capital gains tax may be payable on any growth in value since option exercise.
Unapproved Options Tax Impact
Let’s say that a candidate, Ben, is interested in a job as a software engineer at a Biotech startup.
As an employment benefit, Ben is granted an unapproved option to acquire a 3% shareholding in his employer company for its market value of £10,000.
Four years later, he exercises the option at a time when the shares are worth £100,000, and two years after that he sells them for £150,000 when the company is taken over.
When the option is granted, Ben pays no tax! But upon exercise, he is treated as having received taxable earnings of £90,000 (£100,000 share value less £10,000 option exercise price).
Ben is taxed at his marginal income tax rate, tax of up to £40,500, even though at this stage he has received no cash.
When it comes to the sale of shares, Ben pays capital gains tax on the £50,000 growth in value since he acquired the shares.
Ignoring any reliefs he may have available, tax is charged at a rate of 20%, tax of £10,000.
Therefore, although Ben has benefitted greatly from the opportunity to acquire shares for £10,000 and sell for £150,000, he has had to pay tax of up to £50,500, most of which is payable well before he has received any money (and which might have been lost altogether had the shares collapsed in value).
EMI Scheme Tax Impact
Now let’s run through a different scenario.
Jade is granted an EMI option to acquire a 3% shareholding in her employer company for its market value of £10,000. As in the previous example, four years later she exercises the option when the shares are worth £100,000, and eventually sells them for £150,000 when the company is taken over.
Jane pays no tax when the option is granted, and nor does she pay any tax when the option is exercised.
On sale of the shares, Jane pays capital gains tax on the gain of £140,000 (£150,000 sale proceeds less £10,000 option exercise price). Ignoring any reliefs she may have available, tax is charged at a rate of 10%, tax of £14,000.
So Jane has saved tax of approximately £40,000 as compared to Ben, and paid no tax at all until after receiving her share sale proceeds. For Jane, EMI tax treatment has been hugely beneficial!
The difference here depends upon the fact that there are two main tax benefits.
Firstly, no income tax is usually charged upon exercise of the option.
And secondly, capital gains tax upon eventual sale is usually charged at a reduced rate of 10%.
Who Can Receive EMI Options?
The rules state that EMI options can only be granted to a qualifying employee of a qualifying company.
But what does this mean? Well, each company has the discretion to decide which employees should have options, up to a maximum share value of £250,000 per employee (£3 million for the whole company).
Employees (including directors) qualify if they are contracted to work 25 hours per week for their company or group or, if less, for at least 75% of their working time.
This means that a part-time employee can qualify by working a minimum of two days a week for the company, provided that work elsewhere does not amount to more than 25% of the whole. Importantly - employees don’t qualify if they already own over 30% of the company.
Most tech startups will qualify for EMI options. A qualifying company or group must be independent (not controlled by another company). At the date of option grant, the company’s gross assets must not exceed £30 million, and it must hold less than 250 employees.
The company must carry on a trade and must not (to a substantial extent) carry on excluded activities. These are non-trading activities such as property investment, and various trades including property, banking, insurance, professional services, leasing and hotels/care homes.
This excluded activity mirrors that of the SEIS and EIS initiatives.
How Does EMI Work in Practice?
From working with expert advisors such as us at Jump Accounting, the business should first establish whether it qualifies for the EMI Scheme.
If it does, it should then decide and outline how they plan to implement the EMI scheme, regarding the options described above.
EMI is a flexible scheme, but fundamental points to clarify include:
Which employees should be granted options, and over how many shares;
When should options be exercisable;
What type of shares should be subject to options – e.g. should they be ordinary shares or a special share class designed for options, perhaps non-voting shares;
how much will employees have to pay to exercise options and acquire their shares;
what happens if an option holder leaves the company.
Once these issues are decided, formal EMI option agreements should be prepared clarifying the relevant terms. Upon formal approval, signed by the company and its’ employees, the options are granted!
All in all, EMI Options are proven to incentivise employees and increase the motivation and longevity of a team.
Companies that don’t offer EMI options, particularly those that don’t have the budget to rival large corporation jobs, may be at a disadvantage when it comes to recruiting a valuable team.
If you haven’t already, maybe now’s the time to consider implementing an EMI Options Scheme.
Our experts at Jump Accounting specialise in accounting strategies of this type, that focus on helping our clients reach their next stage of growth, faster.
Reach out to our team to find out more about how we can help, with EMI Options, or any other area of accounting.