Key to the success of any company is the recruitment, retention and motivation of employees who can help to make a success of the business. In sectors where the battle for talent is fierce and where, particularly for early stage companies, paying competitive salaries is a challenge, employers need to identify low cost ways of attracting and incentivising key people.
One of the ways in which this can be done is through offering employees an equity (or share) interest in the company. In addition to the employee-relations benefits that a share interest can bring, the acquisitive nature and growth potential of certain sectors makes them ideal for using share incentives with significant potential employee upside.
One very effective way in which share interests can be provided is through the Government backed EMI options. John Dormer, partner with Wright Hassall talks you through the scheme.
How does EMI work?
EMI has the following key characteristics:-
- employees are given an option (an up-front right to acquire shares) with that right being triggered on certain future conditions being met. As a result there is no dilution to shareholders until those conditions are met;
- the employee can buy the shares on exercise for a price equal to their market value when the option is granted; with the incentive being for the employee to maximise the growth in value of the company;
- the employee incurs no up-front cost on being granted the option and there is no downside risk to the employee;
- on exercising the option, the employee becomes a shareholder and can then realise value from the shares on a liquidity event; and
- due to the Government’s desire to promote employee share ownership through EMI, employees are usually taxed at between 0%-10% on the growth in value of their interests.
The benefits of EMI
EMI offers the following advantages:-
- flexibility in design; with the ability to include conditions that aid in retention and driving performance;
- an opportunity for business owners to articulate business goals and align their interests with those of employees; and
- significant Government-backed tax breaks both for employer and employees.
How much more tax efficient is EMI?
Companies and participants in EMI both benefit from generous tax breaks which are Government and HMRC devised and supported.
For example, a cash bonus of £50k will return just £29k to the employee at an overall cost to the employer of between £45k to £57k.
However, £50k’s worth of gain to an employee via the sale of shares from an EMI option will return over £46k to the employee, leading to an overall efficiency rating of 115%!
Qualifying criteria
As is always the case for Government backed tax incentives, there are some qualifying criteria to be met in order to benefit. These include limits on the company’s size and employee numbers at grant, the EMI company must be independent and must carry on a qualifying trade. Participating EMI employees must also provide sufficient time to the business of the EMI company and may not be a material shareholder (30% or more) in the company already. These conditions however are usually easily met by growing companies.
Key design points
Due to its flexibility, EMI can be designed to meet the required business goals for the company in question. Some of the key decisions that a business owner implementing EMI will need to make will include:-
- which employees should participate?
- when should the options become exercisable and the employees be capable of becoming a shareholders? The options will usually be triggered on achieving a liquidity event, on continued service for a set period of time or on achieving certain milestones in terms of development; and
- what should happen to employees who leave prior to the options becoming normally exercisable?
In conclusion
For a company which needs to retain and incentivise its key people, EMI deserves close attention. In a sector where, for successful businesses, future growth in value and an exit route are distinct possibilities, the risk-free way in which a stake in that future growth can be provided makes EMI a powerful tool in the employer’s armoury..
