By Amal Shah
15 May 2023
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).
The Enterprise Management Incentive (EMI) Scheme is a tax advantaged employee share option scheme which is geared towards smaller entrepreneurial businesses. It provides your employees the opportunity to grant share options up to the value of £250,000 in a three year period. It can be an attractive way to incentivise your employees towards a view of future capital growth and performance targets.
The main advantage of EMI schemes 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 Business Asset Disposal Relief (BADR), while it 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 BADR (other than the need to hold shares representing a 5% interest in the company) are met.
Employee A is granted an EMI option to acquire 2% of the shares in their employer’s company at a market value of £5,000 which is the exercise price. Four years later, A exercised the option when the shares had a market value of £15,000. No tax is paid when the option is granted, nor is there any tax when the share option is exercised.
At a later date, A eventually sells the shares for £20,000. At this point capital gains tax is payable on the gain which is the difference between the proceeds from sale and the market value when the share options were exercised. In this case, a gain of £15,000 has arisen (£20,000 from sale minus the £5,000 from exercise). Assuming no reliefs and A is a basic rate taxpayer, tax would be 10% of the gain resulting in £1,500 in tax.
If the same scenario were to occur outside a tax-advantaged EMI scheme, income tax of 20% (at higher rates to capital gains tax) would be payable upon exercise on the £10,000 (market value when exercised of £15,000 minus the exercise price of £5,000), resulting in £2,000 of income tax payable. Upon sale of the shares, capital gains tax (of 10%) is paid on the £5,000 which is the growth in value since share acquisition, resulting in tax of £500. This would result in total tax paid being £1,000 higher than the EMI scheme of which £2,000 is paid at an earlier date.
There are a number of legal requirements that companies must satisfy in order for their share options to qualify as EMIs, including:
At the time of the 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.
The obvious answer 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.
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
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.
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:
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.
At Gerald Edelman, we are able to assist with the entire process, from the design of the scheme, undertaking the valuation and drafting scheme rules as required, so please do not hesitate to contact us should you be considering share schemes. For more information please email hello@geraldedelman.com.
