Top five tips when considering employee share options

Stephen Oates

Stephen Oates

Tax Director and Head of Entrepreneurial Taxes

One of the more popular routes to incentivise employees without increasing the wage cost is to offer an employee share options. There are many benefits to this route and there are a range of different methods to suit your businesses circumstances - from HMRC approved schemes (Enterprise Management Incentives (EMI), Company Share Option Plans (CSOP), Share Incentive Plan (SIP) to unapproved options and growth shares.

When these types of plans work well, they can drive fantastic results in terms of growth to the business. But all too often, and particularly under diligence at an exit event, we see buyers’ lawyers undertaking a detailed review and uncovering matters that can lead to unforeseen outcomes.

Below I’ve shared my top five tips to take heed of from the outset. Often, I’ve seen HMRC approved schemes, in particular Enterprise Management Incentives (EMI), being challenged further down the line. Being diligent from the outset can mitigate challenges later on.

1. Follow the process

An EMI scheme has, when stripped back, a set of functional steps which should be followed:  

  • Establish whether you can grant EMI options;
  • Agree on a tax valuation with HMRC;
  • Grant options within 90 days of that agreement;
  • Notify the options grant within 92 days of grant;
  • File your annual returns.  

Keep documentary evidence at all times. All too often we come up against a lost HMRC agreement letter, no evidence of option notification or uncertainty around annual returns. From day one, keep your own mini data room including all relevant documentation! It might just save time and money when you come to exit. 

2. Take good legal advice

Early on it is key to work closely with specialist legal advisers (we can help you choose) who can lead you through a range of areas from understanding vesting terms, ensuring that working time requirements are signed off, and drafting appropriate plan rules and option agreements that are tailored to your exact requirements. Working with the right advisers at this stage should allow for a far smoother process when it comes to exercise/exit events. 

In addition, there are key qualifying conditions that must be met when drafting the legal paperwork for the HMRC approved schemes. Speaking with specialist legal advisers should mitigate the chance of errors which could affect the qualifying status for these schemes and thus the potential tax benefits.

3. What's in a valuation anyway?

There are two key things to consider when it comes to valuation:  

  • What is the optimal valuation that can be achieved?  
  • What do I want my employee(s) to pay?  

While not immediately obvious, these numbers don’t need to match. Different founders (and indeed funders) have different expectations on what employees should pay, from standing side by side with the most recent investment round, to “how low can we go”. We always recommend seeking HMRC agreement to the value that will be used (for HMRC approved schemes). The value used/agreed is important as the headline limits (for EMI purposes these are £250k per employee and £3m per company) are based on these values. For the exercise price, you have the flexibility to decide the price that will be paid (i.e. under, equal to or above the market value) and we can provide you with illustrative tax treatments for any scenario. 

4. The procedural part

As noted in Tip 1, once you have granted options, that isn’t the end of the story. There are annual reporting requirements for all equity/options issued to employees. For EMI in particular there is a further HMRC requirement, where you must notify HMRC of what you have done within 92 days of the date the options are granted. This is actioned through HMRC’s online portal for Employment Related Securities (ERS). The ERS online service has its limitations, one being that it doesn’t automatically provide you with a copy of a submission receipt confirming what has been submitted.

Buyers and lawyers like the positive confirmation of actions taken, so we recommend screenshots of every stage and downloading the confirmation receipts. If you don’t have this, a buyer may take the view that the options in question, which should qualify for capital gains tax treatment, should be treated as unapproved options and as such will instead be liable to income tax and potential employee and employers NIC. So, a 10% tax rate could become c55% - take heed and complete the job fully making sure adequate records are kept of all submissions! 

5. I thought this was supposed to be simple?!

Companies, employees and indeed HMRC like EMI. It provides a method of aligning corporate, stakeholders, investor and employee goals and fits within the government’s agenda. It is tax approved, the most tax efficient method of incentivisation on the statute book and well understood by many working in the fast-growth entrepreneurial space. There is a process that should be followed, and with the right advisors in play, you should be able to navigate the various stages, provide a robust outcome that is fit for purpose and when that exit comes, the result will be that the employees are well rewarded. 

There are many other areas to consider, such as vesting terms, valuation methodology, and assessing if the company qualifies to grant options under the HMRC approved schemes. To find out more about these and also how we work with clients to tackle the range of matters discussed, please get in touch with me or one of the team.

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