Top five tips when considering employee share options


Andrew Holloway

Andrew Holloway

Director, Entrepreneurial Taxes


One of the more popular routes to incentivise employees without increasing the wage cost is to offer 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, Company Share Option Plans, Share Incentive Plan) to unapproved options and growth shares.

When these types of plans work well they can drive fantastic results. 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, 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.  

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 would likely always recommend seeking that the value agreed with HMRC is as low as possible, as headline limits (£250k per employee and £3m per company) are based on these values and thus capacity to grant. On exercise price, you have to make flexibility (under, equal, above) 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 tell HMRC what you have done within 92 days of doing it. This is actioned through HMRC’s online portal and once you’re set up it is reasonably straight forward to use. However, the HMRC system has its limitations in that it doesn’t automatically provide you with a copy of a submission receipt confirming what you have done.

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 a full option, which should qualify for capital gains tax treatment, becomes an un-approved option with income tax and potential employee and employers NIC. So, a 10% tax rate could become c55% - take heed and complete the job fully!  

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 with 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, providing a robust outcome that is fit for purpose, and that when that exit comes, can see employees well rewarded.  

There are many other areas to consider, such as vesting terms, valuation methodology, and assessing if the company qualifies to grant options. 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.