Coronavirus Business Interruption Loans and Finance
Jeremy Over | 27.04.2020
20.04.2020 Thomas Clark
What is an EMI Option Scheme?
Away from the legal jargon, an option is just an agreement that gives someone a right to acquire shares at a point in the future.
An Enterprise Management Incentive (EMI) option is a tax efficient option, structured in a particular way to meet specific criteria set by HM Revenue and Customs.
Why I am suggesting EMI options in the middle of the COVID-19 crisis?
The next few months and perhaps longer are likely to be difficult ones for employers and employees alike, and so whilst employers will need to retain and reward key staff so that they stick around to help the company flourish on a future upwards curve, they are likely to want (and need) to do that as efficiently as possible. Further, with resources stretched it may be that employers are unable to incentivise employees adequately on a cash basis.
EMI options allow employers to reward employees on an efficient basis, and on a basis that does not cause a material drain on cash flow.
Broadly speaking, how would an EMI option work then?
I’ve said that an EMI option can be exercised at a point in the future, and the relevant point in the future is usually set at one of the following:
1. When a sale of the company occurs; or
2. When certain performance or other criteria are met.
What happens then?
Once the relevant criteria under the EMI option have been met, then the option holder can exercise the option and acquire the shares.
If the option holder exercises as part of a sale of the company then it is likely that the shares will be issued to the option holder only momentarily before completion of an a sale (with the shares then being sold along with the shares held by other shareholders).
If the option holder is able to exercise following satisfaction of performance criteria, then they are likely to be required to enter into a shareholders’ agreement as part of the process to ensure that their holding of shares is regulated as required by the other shareholders. It is likely that the other shareholders will require the option holder to sell their shares as part of an sale, or that if they later left the company that then the would have to sell their shares back to the other shareholders.
Why would you use an EMI Option, can I not just issue shares?
You can issue share yes, but there a number of reasons why an option may be better:
1. If an employee holds shares and then leaves the company then you would have to buy them back, or at least arrange a transfer of shares. Even if this was required at nil value, you still have the hassle of arranging the transfer. With an EMI option if the employee leaves then ordinarily the EMI option would automatically lapse and no further action would be required (there can be exceptions where exercise is allowed following ceasing employment, for example on death).
2. The company and shareholders will not need to involve option holders in decision making at a shareholder level until the EMI option is exercised. As option holders are not shareholders until the exercise the EMI option, they do not get the right to be involved in decision making (or to receive dividends or returns of capital – unless that allows the option holder to exercise the EMI option).
3. Under an EMI option the option holder can pay for the shares when the EMI option is exercised, and if on a sale, the price can simply be deducted from the consideration due to the option holder. This means that there is no initial cost to the option holder.
4. It may be more tax efficient to issue EMI options rather than shares.
Does the option holder pay for the shares?
The efficient tax treatment depends on how much the option holder is required to pay for the shares when they exercise the EMI option.
Most employers want to use EMI options as a way of giving employees an efficient benefit for staying and increasing the value of the company, and on that basis they try to give the option holders shares on the lowest value basis they can.
The first steps is for the company to prepare valuation, and request HM Revenue and Customs approve it.
The great thing about the HM Revenue and Customs is that having got approval, that value is set and cannot generally be changed. Also, as the shares are usually in respect of a minority of the shares in the company, HM Revenue and Customs usually accept that those shares are heavily discounted (as much as 60%, 70% or even 80% of their value if there was a sale of whole).
Once the value is approved by HM Revenue and Customs the company would often allow the option holder to pay that approved value for the shares. Remembering that that value is probably at a discount to what would be the value on a sale of whole (so the option holder would immediately get some value in the shares even if they were required to purchase at the approved valuation). The tax consequences of this arrangement are very efficient for the option holder because from a tax perspective, the low discounted value is market value, meaning that they have not been given them at a discount and no employee taxes are due. Any increase in value above the discounted value is then taxed on a capital gains basis regardless as to when the EMI option is exercised.
If an option was issued which was not an EMI option, then the tax position would be very different because firstly it is not possible to obtain a valuation when the options are granted (meaning that it may be more troublesome to apply a large discount) and secondly any increase in value from the date of grant to when the shares are issued would be taxed on an employee taxes basis, not capital gains basis.
If the shares were issued to the employee at the outset then again it is not possible to obtain a valuation, and any discount in value that was given to the employee to allow them to purchase shares would be taxed on an employee taxes basis.
Note that as a firm we cannot advise on these tax matters, but it is well worth discussing the tax benefits with your accountant or tax adviser.
There are certain criteria that both employers and employees must meet to be able to qualify for EMI option status but broadly a lot of family/manager owned businesses would be able to put EMI options in place.
Some of the key criteria are as follows:
1. Option holders must be employees within the group, the employer does not however need to be the company issuing the shares.
2. Employees must be working 25 hours a week or if they work less than 25 hours at least 75% of their total working time.
3. Option holder must not have a material interest in the company already.
1. The company issuing the EMI options must not be a subsidiary of another company (it must essentially be the holding company).
2. The company must not have net assets of more than 30 million.
3. The company must not have more than 250 employees.
4. Broadly must be a trading company.
5. There are certain limits on the total value of EMI options allowed to be granted.
So in summary if you cannot remunerate employees adequately in cash terms, or you want to be able to retain or recruit great staff to be able to benefit an economic recovery, EMI options are a great way to do that.