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Most business owners have heard of the Enterprise Management Incentive (EMI) Scheme.
But many are unsure exactly what's involved in setting one up, or how to structure one that genuinely gives their team an incentive to help take the business to the next level.
In this Lunch and Learn, ChadSan's Matthew Gambold explains all.
How the scheme works and why it could be a key part of your start-up's employee incentivisation strategy
How to build a scheme that's effective in incentivising employee performance against targeted metrics
How to make sure your employees are fully engaged in the scheme, so you get the best results
Matthew and his business partner Edward Sanford have spent the past decade and a half building a technology-driven accountancy practice from scratch.
Along the way, he's built up a passion (some may say an obsession!) for supporting the small business community that's the engine room of the UK economy.
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Lightly edited for clarity.
Beth: Hello, everyone, and welcome to today's Lunch and Learn. My name is Beth, and I'll be your host today.
For those of you attending a Lunch and Learn for the first time, Enterprise Nation is a vibrant community platform for start-ups and small businesses.
I'm very pleased to introduce Matthew Gambold, who is the co-founder of ChadSan.
In this session, Matthew will explore how the Enterprise Management Incentive, or EMI, scheme works and why it could play a key part in your start-up employee incentivisation strategy.
If you have any questions throughout the webinar, please place them in the chat or Q&A, and we'll do our best to answer them at the end of the session.
As always, this session is being recorded, and we will send the recording along with some follow-up resources later today. Over to you, Matthew.
Matthew: Thank you very much, Beth. Afternoon, everyone, and thank you very much for joining me this afternoon to talk about the Enterprise Management Incentive scheme, or EMI scheme.
It's a complex scheme, so I'm not going to be able to cover everything in this session.
If there's anything you don't understand, then I'm more than happy to set up a call. There's a QR code at the end of this to talk through things in a bit more detail.
It's one of those tax schemes that lots of people have heard of. Lots of people know it's a good thing, but a lot of people don't understand the technicalities of it and, more importantly, how you can use that scheme effectively to incentivise your employees.
Because if you set it up well, it's a very powerful tool.
Firstly, a little bit about me. I'm Matthew Gambold. As Beth said, I'm the co-founder of ChadSan.
We're a firm of accountants. We started 15 years ago, and we specialise in supporting scale-up businesses from their basic needs right at the start, all the way up to bringing investment in, setting up schemes like this to incentivise employees and eventual exit.
We're going to dig straight in and start with what a share option is.
Often, this is misunderstood: the difference between a share option and an actual share in your company.
A share option is a contractual agreement for a predetermined number of shares to be sold from one party to another at a predetermined price, known as the strike price, subject to predetermined conditions.
Essentially, it's a contract that says: if we meet these conditions, I will sell you this share in my company at a predetermined price, or you have the option to buy that share. You don't have to take that option.
EMI share options are what is known as call options. This means that it's the choice of the buyer, in this case the employee, whether to exercise the option and buy the shares.
So if you're given EMI share options as an employee, you're not obligated to exercise those.
A question I'm often asked is: why bother with share options? It is complex to set up share option schemes, be they EMI schemes or what's known as unapproved schemes. So can't I just give my employees shares?
It would be simpler from an administrative point of view to do that rather than set up a share option agreement. But there are two key reasons why options are often preferred.
First, shares have a value and so are taxable.
If my company is worth £500,000 and I give you, as an employee, 5% of it, then HMRC says you've received those shares, even though they're not cash, in return for the work that you've done for me.
You will be taxed on £25,000, which is 5% of £500,000.
The second reason is that once you've given your employee shares in the company, it can be complicated and expensive to take those shares back.
So if you're giving your employee 5% of your company and that employee leaves, they still own those shares. Those shares are an actual thing that they own.
You would have to set up shareholders' agreements in order to create a mechanism for selling those shares back.
Then there's debate over how much they sell back for and what the tax implications of that are.
So share options are a way to give a promise of future equity without actually handing that equity over straight away.
I'm going to explain a few terms because there are a lot of dates and terms mentioned in conjunction with EMI schemes, and there's often a lot of confusion around those terms.
The first term is the grant date. The grant date is the date that the options are granted to you and, for EMI, the date that the valuation of the company is pinned to those options.
So let's say 31 July. I grant you the options to buy a certain number of shares in the company. 31 July is the grant date.
The strike price is, as I mentioned earlier, the price at which you have the option to buy the shares.
So I might say: "I'm going to give you the option to buy 200 shares at £5 a share in my company at a future date, depending on certain criteria."
Those criteria are the vesting criteria, and this is where a lot of confusion comes in between the vesting criteria and the next term, which I'll come to, which is the exercise criteria.
The vesting criteria are best described as the criteria under which you earn the rights to your options.
So I might grant you the options on 31 July, and you've got the option to buy 200 shares. But the vesting criteria, which are often time-based, will be over five years.
So those 200 share options vest you in the right to those options over a five-year period. That's 200 divided by five, so 40 shares a year.
The exercise criteria are slightly different. This is the criteria under which the options can be exercised.
The vesting criteria are the criteria under which you earn the right to those options. The exercise criteria are the criteria under which you can exercise those options and turn them into actual share capital.
Usually, this is either immediately upon vesting, so as soon as you've earned the right to those share options, you can exercise them.
Or quite often, depending on the aims of your company, if you're building up to a big exit and that's how you want to incentivise your employees, they will be what's known as exit-only options.
That means you can't actually exercise the options and buy the shares until there's an exit event.
The advantage of that is that when you exercise the options and buy the shares, you don't actually have to part with any money because you will buy them at one price and immediately sell them to whoever is buying your company at another price. You will take the difference between those two figures.
So why EMI share options? One word: tax.
You can have non-EMI share options, and companies often do. If they're of a size or type of company that doesn't qualify for EMI options, they will often incentivise their employees through what are known as unapproved share options because there are still advantages to doing that.
But if you're giving your employees EMI-qualifying share options, the tax advantages are fairly significant.
Here's a little example. Let's say that you gave your employee 5% options on a company worth £100,000 at the grant date. So those shares are worth £5,000 at the point that you grant the options.
The strike price, we're going to assume for this purpose, is the same as the valuation at that date, £5,000.
The share value at the date of exercise, let's say five years down the line, is £50,000. You exercise those options and buy them for £5,000, but they're worth £50,000.
Then later, further down the line, these aren't exit-only options, you sell them for £75,000.
If this was an unapproved share option, then as soon as you exercise the shares, you bought them for £5,000 and they're worth £50,000.
That's the same as being given those shares at undervalue, and so you will be taxed on £45,000. If you're a higher-rate taxpayer, £45,000 at 40% is £18,000.
Further down the line, you then sell at £75,000, so you've made another £25,000 gain.
That will be taxed at capital gains tax rates, which are normally 24%. If it qualifies for something called Business Asset Disposal Relief, then you will pay a lower rate of tax, 18%, but you have to have held those shares for at least two years to qualify for Business Asset Disposal Relief.
EMI share options, on the other hand, have the value of the shares pinned at the date of grant.
So the value is pinned at £5,000. When you exercise those options, you pay £5,000 to buy them. They're worth £50,000, but there's absolutely no tax at all at the point you exercise the options and buy the shares.
The tax arises when you sell the shares. So if you sell them for £75,000 further down the line, you bought them for £5,000 and sold them for £75,000.
All of that £70,000 gain is taxed at capital gains tax rates, which are much lower than income tax rates.
So you pay 18% on the whole £70,000 gain, again, if you qualify for Business Asset Disposal Relief.
That gives a total tax bill of £12,600, compared to £22,500 for unapproved options.
A little note on Business Asset Disposal Relief. If they are EMI-approved options, the period that you hold those options also qualifies for Business Asset Disposal Relief.
So you might have been issued the options two years ago. As soon as that two years of holding the options is up, you qualify for the 18%.
It's a lot easier to qualify for that beneficial rate of capital gains tax if it is an EMI option rather than an unapproved option.
So who qualifies? To qualify to issue EMI options as a company, there are a number of criteria.
Number one is independence. You can't be under the control of another company.
So the EMI share options must be in the top company in the group, if you've got a group of companies. The parent company and all of the subsidiaries of that parent company must qualify. They must be carrying out a qualifying trade and they must meet all the other criteria.
Then there are qualifying trades. Certain trades are excluded, including accountancy, legal services, insurance, farming, property development and hotels.
So if your business, or if it's a group of businesses and any of the subsidiary businesses are operating in those sectors, then you're unlikely to qualify for EMI.
The next criterion is the size of the company. This has been expanded significantly recently. The size criteria used to be a lot lower, but EMI options are aimed at smaller companies.
Your gross assets at the time that you grant the share options must be less than £120 million, and you must have fewer than 500 full-time equivalent employees.
Next, you need to have a UK permanent establishment. That doesn't mean that you can't be an overseas company with a UK subsidiary, a qualifying subsidiary.
Overseas companies can qualify, but they must have a UK permanent establishment within their group.
Then the shares must be ordinary shares. You can't issue options for shares that are redeemable shares under an EMI agreement.
That means you can't have a guarantee of getting your money back or a guarantee of the return of those shares. They must be ordinary shares.
You can issue ordinary shares with different classes. The classes of shares issued under an option agreement don't have to have voting or dividend rights. You can restrict those, but they must be ordinary shares.
Finally, there's a limit as to how many EMI share options a company can issue. That total limit is £6 million, measured at the value at the date of grant.
So once you've issued £6 million worth of options, you can't issue any more as a company.
Next up is who qualifies as a potential recipient of EMI share options, meaning your employees.
Number one, you must be an employee. You've got to be a full-time employee of the company, or a subsidiary of the company, that is issuing those options.
HMRC defines that as working at least 25 hours a week for that company. Or, if you're working less than 25 hours a week, you must be spending at least 75% of your total remunerative working time.
So you can work less than 25 hours a week, but it's got to be your main employment.
You must also not hold a material interest in the company that is issuing the options.
That material interest is defined as 30%. So if you are a founder of a company, usually you can't issue yourself with EMI options.
It's important to note that that's 30% immediately prior to the grant of option.
So if you're a 25% shareholder and you're issued with options over a further 20%, those options will take you over 30%. But as long as you're not over 30% at the point the options are granted, then you should qualify.
Again, there's a limit on how many options each individual employee of a company can hold.
The £6 million limit is for the company, so that's all the options it has issued to all of its employees.
Each employee then has a maximum number of unexercised options that can be held at any point of £250,000. Again, that is measured at the value at the date of grant.
That value at the date of grant is really important. We'll come on to how that plays into the way an EMI option works.
Next, disqualifying events. Once the company has qualified, you've qualified and you've been issued with new options, certain things can mean that those options, even if they qualify at the point they are granted to you, become disqualified.
Often, that is if you leave employment. So you're a full-time employee for a company. They issue you with options, and you leave that employment.
There are other things that could happen that disqualify the company, for example.
Under those circumstances, if the EMI agreement allows it, and often the EMI agreement will say to employees that if you leave employment your options lapse and you can't exercise them, then there are rules to follow.
If the agreement does allow your employees to keep hold of those options after they've left employment, then they have 90 days after that disqualifying event to exercise their options and retain their EMI tax treatment.
So if I've got options in my employer's company and I leave that employment, I've got 90 days from the date that I leave to exercise the options and buy the shares, and still get that preferential tax treatment that I demonstrated in an earlier slide.
After that, the options are still held by me, again, if the agreement allows it, but they become unapproved options. So I don't get the tax advantages when I exercise them and buy the shares.
So how do I build an effective EMI option scheme for my company?
I've seen, over 15 years of running an accountancy practice and working with hundreds of small businesses, that people often come to me having either set up an EMI scheme or wanting to set one up.
They know that it's a good thing and they know there are tax advantages, but they don't really understand what those are.
Quite often, they've set up EMI schemes with a famous solicitor who's used a template, given it to them, and they've handed out those options to their employees, but they don't really understand them.
So the first thing is you want to build an option scheme that is fit for purpose and fit for your company.
You want something that's going to attract employees who buy into your vision for the company, by making them a direct beneficiary of that vision being achieved.
You need to be clear with your employees about what your aim is for that company, whether it's building it up to a big exit and a payment there, or building it up to be hugely profitable with options issued and shares issued so that your employees can benefit from dividends.
You need to make sure that you are properly telling that story to your employees, so they understand what the benefit to them is. That's going to attract them into your company and into the scheme.
To that end, the vesting and exercise criteria that we talked about before are the key tools in incentivising your employees to meet their objectives. Setting those correctly is essential for a scheme to be effective.
If you bring someone on and you say, "I'm going to give you some exit-only options", but a couple of years in, it turns out that you're not really likely to sell the company and you're not really intending to sell it, then those share options aren't going to be effective in incentivising your employees.
They're not worth anything if you don't sell your company, by definition of them being exit-only options.
Most importantly, as I mentioned earlier, to be effective, a business owner and his option holders, his employees, must understand how the scheme works and the potential benefits to them.
Again, too often I've seen EMI options being issued to employees, and they go, "That's nice", stick it in their drawer and don't understand exactly what it is, how it works, what the tax incentives are or how they can benefit from it by working towards the objectives that it's meant to encourage.
Education is an essential part of this. As a business owner, you need to understand how the EMI option scheme works, and you also need to communicate that to your employees and keep communicating it to your employees as well.
We often recommend, for example, if it's an exit-only option, that you keep your employees abreast of how much the company is worth.
So you build a metric for value in your company. Each year you say: "Look, the company's worth this."
They can then look at their options and go: "I've got the option to buy shares at £5,000. They're now worth £20,000. If I keep working, keep adding value to this business and keep increasing the value, eventually there's going to be an exit, and I'm going to be up by X amount."
Communication is a vital part of setting up an EMI option scheme.
It's not straightforward or cheap to set up an EMI option scheme. If you don't do it properly, then it can be a big waste of time and money. If you do it properly, it could be a hugely effective tool to incentivise your employees.
Finally, the practicalities. How do you set up an EMI scheme?
Step number one, value the company and get that valuation approved by HMRC.
You need a formal valuation done of your company, and that needs to be sent to HMRC alongside a VAL231, saying: "I want to set up an option scheme. This is how much I think my company is worth. This is how much I think each share is worth."
That's in order to pin the price to that valuation. HMRC will look at that valuation. They will write a letter back and say they agree it, hopefully.
Sometimes they'll come back and query certain things, and there will be communication back and forth between you and HMRC.
But once HMRC has approved it, you'll get a valuation letter with a date on it. You then have to grant the options within 90 days of that date for the valuation approval letter to be valid and for the options to be valid EMI options.
If you go over that 90 days, then the valuation isn't worth the paper it's written on, and you're back to square one. You'll have to submit a new valuation and get HMRC to approve it.
So it's really important that you've got your ducks in a row so that when that valuation letter comes through, you can act straight away, start setting up your option scheme and get all the paperwork agreed and signed off.
Between valuation and grant, so after HMRC has approved the valuation and sent the letter, but before the date that you grant the options, there must be no material changes in the company's circumstances.
Otherwise, it can render that valuation approval invalid. So you can't raise any new funds. You can't win or lose major customers.
Well, you can, but you would need to go back to HMRC and get them to re-agree the valuation on the basis of the changed circumstances.
You can't agree a sale of the company because if you're agreeing the sale of the company, you're by definition agreeing a value that is going to be different to the value HMRC approved.
You can't pay out any material dividends. If it is run-of-the-mill dividends that the company has always paid out, then that should be OK, particularly if you've disclosed it to HMRC as part of the valuation process.
But if you say a company is worth £1 million and, between doing the valuation and issuing the options, you pay £200,000 of that £1 million out in a big dividend to the existing shareholders, that's going to materially affect the valuation of the company and render the valuation approval from HMRC invalid.
So you've got a valuation approval. You've issued your options. You must then register the EMI scheme with HMRC and submit details of any options granted by 6 July following the end of the tax year in which the options are granted.
By tax year, I mean the UK's normal tax year, so 5 April.
So if I was going to issue EMI options in my company to my employees right now, I need to have registered the scheme with HMRC and told HMRC details of the options that have been granted by 6 July 2027.
If you don't do that, those options and that EMI scheme are invalid, and you're going to have to start from scratch.
This deadline is a lot more generous than it used to be. It used to be that you had to register options with HMRC within 60 days of granting the options.
They've now relaxed that slightly, so it's 6 July following the tax year end.
Then you have to keep telling HMRC. Once you've got an EMI share option scheme set up, you need to make an annual return to HMRC, telling them about any new options that have been issued and any options that have lapsed.
For example, if an employee has left and the option has lapsed, you need to tell HMRC about that. You also need to tell them if any options have been exercised.
You need to keep telling HMRC about any changes to the scheme in the form of an annual return.
If there have been no changes, if you've not issued any new options, if you've not exercised any options, or if no options have lapsed, then it's a simple nil return to HMRC.
But you still need to make sure that you file it because otherwise, again, you jeopardise the scheme qualifying, which could land your employees with big tax liabilities further down the line that they weren't expecting.
That is a whistle-stop tour of EMI options. Again, it's a complex subject.
It is a great scheme, and it is certainly worth looking into if you want to incentivise your employees by giving them a stake in the success of your business.
But it's something that you need to think carefully about when you're setting it up, for it to be effective. Any questions?
Beth: Great. Thanks, Matthew. We've got time for a few questions, if that's OK.
At what stage of growth should a company seriously consider implementing an EMI scheme?
Matthew: It's a good question. I would say the earlier you do it, the better.
It depends on the point where you want to bring in high-value employees that you want to really buy into your vision.
They're not founders, but they are key employees who will help you get to where you want to get to.
That's usually the point at which you need to look at setting up an EMI option scheme.
If they are the sort of employees who will be incentivised by that, it will mean that you can probably offer them a lower salary than you normally would because they've got this as well as their salary.
They know they're going to get a payout if the business succeeds in the way that you hope and in the way that they will help it to.
The caveat to that is, as I mentioned before, it's unfortunately not cheap to set up an EMI scheme.
So you need to make sure that you've got the funds available to set it up and to deal with the ongoing compliance.
If you have the funds available, then the earlier, the better because the values will be lower. And, as I said, when you set up an EMI option scheme, the value is pinned to the value on that day.
So the lower the value, the better for your employees and the more attractive those options will be for them.
Beth: Absolutely. I know you touched on this earlier, about employees not fully understanding share options.
In your opinion, what would be the best way to explain the value of an EMI scheme to them?
Matthew: I think there have to be some numbers in there. Number one is the story.
It is: "Look, if you come on board, this is what I want the company to achieve. This is what I think it could be."
They've got to buy into what you think the company can achieve.
Because if you're giving them options and you say, "I'm going to sell the company for £10 million in five years' time, and you're going to make hundreds of thousands of pounds", if they don't buy into that story, then it's pointless.
So the first step is getting them to buy into what the company can achieve and what they can help the company to achieve.
The second step is a simple calculation.
Show them: "If we achieve that, you'll get options at this value. You'll sell them at this amount by here. This is the gain you're going to make, and this is the tax you will pay compared to the tax you would pay if I just gave you shares or if it was an unapproved share option scheme."
So it's the story, number one, and the calculations, number two.
Then keep those calculations updated and keep that narrative going with your employees, so they can see the value of those options increasing as they go on and they don't just forget about it as a piece of paper in their drawer.
Beth: That's great. Great answer. Thank you. How often should businesses review and update their EMI scheme as the company grows?
Matthew: Again, it depends largely on how fast the company is growing and whether you need to bring new key employees in.
I would say you probably need to give it at least a high-level review once a year, just to have a look again as part of that education piece for the employees who are holding the options, to keep them invested in that scheme.
Then you should consider whether they need new options and whether circumstances have changed.
So you're aiming for a £10 million exit, but actually it's only going to be a £5 million exit. They may need some more options to incentivise them.
Or you've brought in some new key hires who you want to issue options to, and who are potentially going to look at other legacy employees who have options. You want to make sure that they're all on a level playing field.
So I'd say a high-level review every year, but that doesn't necessarily mean you need to issue new options every year.
Beth: Great. Just one more question, and this ties into what you've already talked about.
It's about keeping employees engaged with the scheme after that initial excitement has worn off. So you mentioned keeping that narrative open and updating the numbers. Is there anything else you can think of?
Matthew: Yes. I think it's keeping the narrative open and updating the numbers.
We set up EMI schemes for our clients. We spent so long getting frustrated with clients who had got lawyers to set up their schemes.
They weren't fit for purpose. They didn't do what they needed to do. The client didn't understand them. The employees didn't understand them, and frankly, they were a big waste of money.
So we've started setting up EMI schemes for our clients, and we do that via a platform called Vestd.
That platform is built around two things.
Number one, it enables accountants and people with knowledge of schemes to sit down with their clients and build a scheme that's fit for purpose.
Number two, it's also a client engagement tool.
Every employee who's got options will have a login to Vestd. If you're updating your valuation every year, they can have a look and they'll get a nice little chart showing the value of the options as they increase. So a platform like that is helpful.
Education is one thing. But life is busy, and quite often you forget to do that. If an employee has a portal they can go into and say, "OK, my options are worth X amount at the moment", then that's a powerful engagement tool.
Beth: Absolutely. Having that kind of visible indication definitely helps.
Well, thank you so much, Matthew. That's all we have time for today.
Thank you everyone for attending. I have popped Matthew's LinkedIn and Enterprise Nation adviser profile in the chat, so please do feel free to reach out. I've also shared the link to ChadSan as well.
Once again, thank you, Matthew, for joining, and thanks everyone today. The recording will be sent later as well for those of you who have asked for it.
Thank you very much, and enjoy the rest of your day.
Matthew: Thank you, everyone. Goodbye. Thank you very much, Beth.
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