In the current tax regime with ever increasing anti tax avoidance measures in place and vigilance from the HMRC: here is a tax efficient deal for employees and employers which statistics show improve the business – what can be wrong with that? Enterprise Management Incentive options (known as EMIs) are just that and are particularly suited to fast growth technology companies.
Set out below are some of the supporting reasons of why EMIs are a great retention tool for fast growth businesses :
- A typical fast growth technology company starts with humble beginnings and grows rapidly hopefully to be bought up by a bigger player in a relatively short time frame – usually 5-10 years maximum. EMI options are particularly suited to that type of business plan because there is a very short holding period required to satisfy the conditions for tax relief. The EMI option only needs to be held for 12 months to qualify and most businesses with a little planning can satisfy that.
- Having been through redundancy programmes particularly in the South East there is now a skills shortage. However, the pressure on expenditure remains as intense as ever, if not more intense as everyone pays particular attention to the bottom line and wage inflation is not balanced by inflation in all cases on spend. EMI legislation allows employers the opportunity to supplement straight pay with the genuine opportunity of being part of something much bigger if the business does well. If you are not offering equity as well as pay and bonuses your competitors will be.
- If you grant EMIs in the early days before the revenue streams start to flow it is possible that the EMIs can be awarded at “nil cost”. Nil cost means that apart from the par value of the shares under EMI option there is nothing for the employee to pay on exercise and acquisition of the shares. If your business is more established you can still award EMIs but there may be some tax for the employees to pay on exercise. The amount of the tax payment required from employees on exercise depends upon the particular facts but can often be modest, especially if the correct proposition is put to HM Revenue and Customs – the valuation techniques are varied but can lead to great results for employees since the valuation is fiscal rather than commercial. One great advantage of EMI is that it is a one way bet and the employees are never forced to exercise.
- Having established an EMI option plan it can be re-cycled for future EMI option grants which can encourage employee retention. A very flexible feature of EMI is that the awards are discretionary and different awards can be provided to different employees. As long as no more than 30% of the issued shares are awarded to any one employee there is no restriction on the number of times an employee is granted an EMI option. A variation on the theme of multiple grants is to provide for vesting – vesting means that part of the option vests over the lifetime of the exercise period. Vesting could be based on years, for example, 20% of the EMI option vests over 5 years. Alternatively, vesting can be based on targets, for example, if profits hit certain thresholds. Exit only EMI options are common – these options provide that if the business is not sold by a certain deadline the EMI option lapses. Exit only EMI options are the easiest to implement and very common in technology companies.
- Professional investors in fast growth technology companies are familiar with EMIs and will expect to see most senior management teams motivated via EMIs. Professional investors will usually agree to dilution of their investments up to agreed percentages if EMIs are awarded to employees.
- In terms of tax the benefits of an EMI they are an easy sell for employees – the 10% capital gains tax charge on profits on sale or exit which is delivered under EMI compares favourably with rates of taxation applicable to other forms of taxation.
- There are some limitations to EMI which can apply to high growth technology companies. A major limitation is that there is a requirement to be employed which rules out consultants and non-executives. There are other types of incentives which can be used for consultants and depending upon the grant the terms can be tax efficient. It does pay to check out the limitations to make sure you are not caught out.
Catherine Gannon
Catherine Gannon runs the tax commercial team. Over the years the team have implemented many EMI option awards across many industry sectors but with a strong focus on high growth technology companies. The commercial overview means that the team think not just about the terms of the EMI option but also the longer term implications such as investment rounds and sales.