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An Introduction To Enterprise Management Incentives

An Introduction To Enterprise Management Incentives
Amal Shah

By Amal Shah

29 Sep 2020

The Enterprise Management Incentive (EMI) scheme is an approved employee share scheme specifically designed for trading companies with growth potential.

The enterprise management incentive allows employers to grant share options to key employees tax efficiently, as a reward for their efforts within the business and/or to retain and incentivise key employees long-term. They provide employers and employees with significant tax benefits and are much more flexible than other tax favoured share arrangements.

A large number of EMI schemes are ‘exit-based’ with the share options being exercisable on a sale or flotation of the company. Most owner-managers prefer this type of arrangement since the option holders do not become shareholders until shortly before the sale of the company. This ‘rewards’ the employee option holders with a share of the sale proceeds (taxed at beneficial capital gains tax rates).

What are the key advantages of Enterprise Management Incentive schemes?

The main advantage of enterprise management incentives is that employees can acquire shares at a later date at the market value at the grant date (usually at a significant discount), and exercise without an income tax or National Insurance charge. On a subsequent sale the profit will be taxed under the capital gains regime, potentially at 10% with entrepreneurs relief (ER) whilst ER remains in existence. This is so long as the shares are not sold within 24 months of the option grant and all other requirements relating to entrepreneurs relief (other than the need to hold shares representing a 5% interest in the company) are met.

Other key advantages of an enterprise management incentive scheme include:

  • The company can deduct the cost of setting up and running an EMI scheme and to deduct the gain on the shares between the grant and the date of exercise from their income for corporation tax purposes;
  • The company can choose exactly who receives the option. However, they cannot be distributed to employees who have 30% or more of the company’s shares;
  • The options can be granted conditionally, subject to performance criteria;
  • The company can decide the exercise price and the option period;
  • The market value of the shares can be agreed in advance of the option grant with HM Revenue and Customs

(HMRC); Voting restrictions can be placed over the shares subject to EMI options to protect the owner-managers’ position.

Which companies qualify?

There area number of legal requirements which companies must satisfy in order for their share options to qualify as EMIs, including:

  • The company must carry on a “qualifying trade” in the UK. If the option is for a group of companies, at least one company in the group must carry on such a trade;
  • The company (or group of companies) must not have gross assets exceeding £30 million at the time the share option is granted;
  • The company whose shares are used may be listed or unlisted on a stock exchange, but it must be an independent company. In the case of a group of companies, the options must be over shares in the parent company to meet the EMI requirements;
  • The company (or group of companies) must have fewer than 250 full-time employees at the time the share option is granted;

All employees must work at least 25 hours a week or 75% of their total working time for the company.

Share option value limits

At the time of grant an employee may not hold unexercised EMI options worth more than £250,000. The company may issue up to a total of £3 million unexercised share options to all its employees. The options must be exercised within 10 years

When is the best time to grant EMI shares?

The obvious is when share prices are low, that is an opportunistic time to grant options, because of the possibility of greater gains for employees in the future, when the share price rises.

For owner managed companies thinking about granting EMI share options, there are points to consider regarding the timing and valuation.

Share dilution – The issue of new shares on exercise of share options, will result in dilution for existing shareholders. Granting EMI options at an early stage in the company’s development should result in larger gains for employees and lower dilution for founding shareholders

Looking for investment – Consider granting EMI options before any definite negotiations are entered into. Even if you haven’t had the investment yet you may need to inform HMRC. If you are discussing the value of the company with a third party, you should disclose this when agreeing the valuation with HMRC. Those discussions may result in a higher valuation in the shares, so it is advisable to grant options earlier rather than later to make the most of a pre-investment share value.

Exit – If “exit only” EMI options are being granted, get the options in place as soon as you can and well before you are commencing discussions with potential buyers. This is because:

  • If Heads of Terms have been entered into with another business wanting to buy your company, your company may not qualify for EMI because this could be regarded as “arrangements” whereby your company could cease to be independent;
  • As mentioned previously if the company is sold within two years of the EMI options being granted, the EMI option share will not quality for the expected capital gains at 10%;
  • The nearer to the sale of the business, the higher the valuation is likely to apply to the shares, and the smaller the potential gains for the option holder.

An important part of the success of your EMI scheme is the value of your company’s shares. As the company owner/manager, you will have the knowledge of how your company is performing financially and how it is likely to perform in the near term. You also know whether you require outside investment, or you want to sell, and the value that you want. From this you will be able to gauge the optimum timing for the grant of EMI options for your company.

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