Share options are a common currency today for attracting and retaining staff in fast-growth businesses. Enterprise Management Incentive (EMI) share options are one of the share option solutions frequently used to incentivise, and part compensate, employees in their commitment to an aligned goal of increasing the value of the business.
There are a few important points founders should consider though and common mistakes to avoid when offering an EMI scheme.
Understanding the basics of EMI share schemes
A share option gives your employee, known as the option holder, the right to buy shares in your company at a pre-defined price at a point in the future. Practically speaking, it means your employees enter a contract granting them the right to purchase shares in your company at today’s value but at a point in the future when they’re much more valuable (known as exercising their options).
How EMI share options are exercised
Often the exercising of share options is only permitted at the same time as the company is sold, so in practice, your team never actually hold shares in your company; they buy them as the sale goes through and sell them to the acquirer as part of the sale.
That isn’t always the case though. It’s just as acceptable for your staff to exercise their options, purchase their shares and remain shareholders in your company at a future point, often based on performance and/or time spent in the business. It all depends on what sort of scheme you put in place.
EMI schemes are a tax efficient option
EMI plans are specifically designed by HMRC as a tax efficient way for your employees to become shareholders in your company and share in the value they’ve helped create. However, there are some restrictions on these plans.
Too often business leaders get swamped by the perceived complexity of this tax efficient plan and fail to actually think it through. They ultimately implement a plan which drives the behaviours they desire and delivers the rewards they envisaged.
EMI schemes are extremely tax efficient for both the company and your employees. The company pays no Employer’s National Insurance on the scheme and your employees suffer no tax until they eventually sell any shares they’ve purchased. That tax is charged as a capital gain on the difference between the price they purchased the shares for (the exercise price) and the price they sold the shares.
Common mistakes to avoid when setting up an EMI scheme
Not understanding the EMI scheme you want
EMI share options require complex legal agreements, often 20 plus pages, so can be very daunting for someone with little legal experience and it’s difficult to pick out the key elements within the agreement.
The process for implementing a scheme often starts with the drafting of plan rules rather than first defining what you’re trying to achieve. You should always start with a session to establish the intention of the scheme and make the key decisions which the legal experts will take away and turn into formal documentation.
Be sure to request a key terms sheet as part of the setup. As mentioned, share option plans and agreements are complex legal documents which are not easy to navigate so having a simple one-pager showing the key terms will be make everyone’s life easier when trying to remember what decisions were made years earlier.
Overall, it’s your scheme so you need to understand your options and implement the scheme you want commercially.
Getting compliance wrong and not protecting your employees’ tax
In order to protect the tax status of the scheme, there are a number of mandatory compliance activities and HMRC afford little wriggle room if they’re not followed. They’re not complicated, so shouldn’t be expensive, but can have massive implications if they’re overlooked.
Robert Dunk from The Legal Director advises, “Being sure you get the documentation right for compliance is key. There’s automated software that can generate the documentation for you, however, although useful, it doesn’t always produce the right results. Having someone ask the right questions to be sure that your EMI scheme is suited and compliant offers a higher degree of assurance.”
Not establishing an option pool for EMI share options
How big should the option pool be? It seems like a simple question, but it’s often overlooked despite being something that all shareholders (founders and investors) need to be aligned on.
As new investors are brought into the business each will have views on what proportion should be available to staff and having your thoughts crystallised, perhaps even documented in the articles, will strengthen your hand to retain your favoured position.
It’s also worth considering how dilution might affect the option pool. On a large funding round, do you want the option pool to remain the same in number and so reduce the pool as a proportion of the company or do you plan to increase the shares available so the proportion available remains constant?
Overlooking the importance of leaver provisions
Often the goal of the scheme is to retain staff and keep them aligned and motivated until an exit. So, the plan might dictate that your employees can only exercise their options when the sale happens. But what happens if someone leaves?
Leaver provisions should be considered. If a member of your team leaves employment, do you want them to retain their options/shares or should they return on termination of employment? Is that answer different if your employee resigned or retired? These are all considerations to be decided and write into the plan rules. In addition, HMRC imposes certain minimum requirements in relation to the ongoing rights of individuals to hold EMI options if they leave employment or die. What you'd like to achieve in relation to properly incentivising employees needs to be managed alongside what's possible within the HMRC parameters.
Missing out on additional vesting conditions
The vesting period is the time from when an option is granted to your employee to when they are able to exercise them under the scheme rules.
Often the only vesting condition is that the individual remains an employee of your company when they exercise their options But, it’s a great opportunity to place additional criteria on the vesting. This is a chance to drive behaviour so attaching vesting conditions aligned to behaviours you want could be really beneficial to the goals of your company.
Not considering the value at which you want to issue the options
The strike price is the price at which you agree each staff member can purchase shares. While it’s typical to issue options at as low a strike price as possible (discounted from the enterprise value to reflect the various restrictions around the option scheme) that price might not always be the right one to issue options at.
If your company is very young, where cash is perhaps tighter, the granting of share options at a vast discount from market value will be seen as part of the remuneration package. Also, it will be considered as compensation for taking the leap of faith in committing to an early-stage company.
If your company is a more established (and potentially less risky), it may be that be more appropriate to issue options at the actual market value without any discount so your employees are rewarded for the value they actually create rather than receiving that value from a discount immediately.
Any market value needs to be agreed with HMRC before options are granted but there is no reason you can’t issue options at a strike price greater than that agreed market value.
Communicating percentage holding and not number of shares
Be clear with your employees whether it’s percentage or actual number of shares and the conditions of their holding. For example, an employee might be told they’ve got 2% of the company in share options, only to find that percentage to be diluted by 50% on a big fundraise. That employee could feel demoralised about the fundraise, and their options and all of the benefits of the scheme are lost.
Of course, it doesn’t actually make any difference to the overall position for your employee or company but if that was framed as 5,000 share options, the number of options wouldn’t have changed with the fund raise so it would have likely remained a positive event all round.
Final word on EMI share options
Robert offered this further insight, “Be sure that the EMI scheme is the right mechanism for your company to incentivise your employees. There are other option schemes available and other tax incentivised routes available to offer to your team. Take your time to consider carefully whether EMI works for you. Don’t rush through the process.”
EMI schemes can be a hugely powerful tool in attracting and retaining talent and rewarding your employees. However, their implementation does require some thought and planning to ensure they drive the right behaviours and deliver the desired outcome for you and your team.