Advances in technology, social media, globalisation and the UK’s exit from the European Union mean that there is increasing pressure on all of us as business owners. Private equity providers will often say there are just three things they look for in any business:  management, management, management! For all of us running our companies we need to embrace the same mantra.  The need to attract, retain and motivate your key team members who are your managers or prospective managers. So if you are considering offering an employee share scheme to your team, what are your options?  Where do you begin?

There are technical tax and legal issues with which to grapple.  But those technicalities are secondary:  to identify the alternatives that are right for you and your company it will first be necessary for you to take a step back and ask yourselves the following questions.  Once you have done so the alternatives open to you will become clear.

Q1:  Do I want to invite employees to become co-owners sharing in dividends, capital growth and voting control?

You may find this question a difficult one to answer or the answer may be a clear no.  Either way, and providing your company qualifies to grant tax-efficient Enterprise Management Incentive (EMI) options, then you may decide to award your team exit-conditioned EMI options. These can be thought of as a cash bonus paid only if you sell your company.  Employees should only pay 10% tax on the option gain.  This assumes entrepreneur’s relief is available to them as it should be: the 5% shareholding threshold does not apply to shares acquired through an EMI option.

An EMI option can only have a life of ten years.  So where a sale of your company is not likely within ten years this type of option may not be attractive to well-advised employees.  You could instead structure the option so that it can be exercised from year nine even if there is no sale of your company.  This then brings us back to that question of employees sharing in dividends, capital growth and voting control.

Q2:  Why would I want to use an EMI share option scheme?

The key thing to note about EMI options is that they ensure that the growth in value of option shares from the date of award (called the grant date) to the date of acquisition (called the exercise date) accrues without triggering a charge to income tax (or worse still PAYE including employer’s NIC at 13.8% if you are at the point of sale and your shares are readily realisable securities).

Q3:  What are the qualifying conditions for EMI options?

To qualify to grant an EMI option your company cannot be undertaking an excluded trade (such as property investment or share dealing).  It must also not be controlled by another company and not have gross assets of more than £30million or more than 250 employees. There is also a limit on the value of the award of option shares.  The option holders must be employed by your company and contracted to work not less than 20 hours per week.  Employees who work less than this number of hours can qualify if their employment amounts to at least 75% of their working time.

Q4:  What are my alternatives if an EMI option scheme is not available to me?

You could think about a scheme under which employees acquire shares on day one (this may mean you need to re-base your company with preference shares (see the answer to Q2)).  If you want shares to accrue or vest over a period of time you can replicate, in economic terms, that desired vesting schedule in the terms of the award so an employee-shareholder who leaves before a tranche has vested can be required to surrender those option shares for nil consideration. These schemes are generally called restricted share schemes.  Care must be taken to avoid an income tax charge where share are sold.  A restricted securities election is a good idea.

Another alternative is to award employees a non-tax advantaged (or unapproved) share option.  The advantages of the unapproved share option is simplicity.  The disadvantage is the tax cost: the employee will pay tax at rates of up to 45% on the option gain and the company will have to pay 13.8% employer’s NIC assuming the option is exercised just before a sale of your company.

There are a number of other tax advantaged share schemes including:-

• a Company Share Option Plan (CSOP) which allows up to £30,000 worth of shares to be put under option and can sometimes be useful if a company does not qualify to grant EMI options;
• a Share Incentive Plan (SIP) where free shares worth up to £3,000 per annum can be awarded to employees. A SIP can also be used to award additional shares (called, matching or partnership shares);
• Save As You Earn Share Scheme (or SAYE Scheme) where employees enter into a seven savings plan that allows them (on maturity) to pay the exercise price on share options that can be granted at only 85% of the day one market value.

However, these tax advantaged schemes are generally more costly to establish and administer so it tends to be larger companies, particularly listed companies, who choose these types of scheme.

It is the EMI option scheme which is overwhelmingly the most popular (or the restricted share scheme if the EMI scheme is not available) for private companies.

For further information on employee share schemes, please do not hesitate to contact an Everyman Legal Solicitor on 01993 893620 or email everyman@everymanlegal.com