What is an Enterprise Management Incentive (EMI) scheme?
An EMI is an Employee Share Option scheme. An employee is granted an EMI option to acquire shares in the employing company (or its parent company) for a set ‘exercise price’. The exercise of the option can be subject to time-based vesting and/or meeting performance conditions.
Advantages of EMI schemes
- Aligns the interests of the employee with the shareholders.
- No complication of creating a minority interest or voting conflicts if the option is only exercisable on an exit (see below).
- Employers can attract executives who are key to the business (but whose salary expectations are more than the employer can afford in salary terms) with the promise of equity in the company (subject to performance targets).
- Low risk for employers, if the employee doesn’t meet the performance targets set (or there is no exit on an ‘exit only’ scheme), they won’t receive any shares. Conversely rewards employees tax efficiently if they do meet performance conditions.
- No risk to employee - if the value per share sinks below the exercise price then they can walk away with no cost or tax consequences. Compare this with a share the employee might have been invited to purchase which decreases in value.
- Entrepreneurs' Relief is more accessible – the requirements to have a minimum 5% holding and voting shares are not applicable to EMI shares.
- Highly flexible and relatively easy to set up and administer.
The tax benefits of EMI schemes
Provided the legislative requirements are met:
- there will be no tax on the grant of an EMI option
- there is no income tax liability on the exercise of a qualifying option provided that the exercise price was equivalent to market value at the date of grant and the date of exercise is no more than ten years after the option grant date
- on disposal, Capital Gains Tax (CGT) would apply after the deduction of any unused portion of the current CGT annual allowance and entrepreneur’s relief might be available (if the holding meets the relevant conditions)
- Current CGT rates are 20% for higher rate tax payers. Compare this with the equivalent higher income tax rate which is 40%.
Relevant statutory conditions
- In order to qualify for EMI purposes both the company and the participant have to meet certain statutory criteria.
- There is an individual limit on the unrestricted market value per individual participant of £250,000. This value is calculated at the time of grant.
What kind of incentive are EMI schemes?
An option is an indirect form of employee share incentive meaning that the employees who are granted EMI options will not directly own any shares until the option is exercised. Typically options are not exercised until an ‘exit event’ such as a change of control in shareholders, a sale of the business and assets or a flotation meaning that the employee will only become a shareholder for a moment in time immediately before the exit before selling their shares.
However, if an employee might become a shareholder otherwise than on an exit, employers will want to consider the following:
- whether a new class of shares should be created and used
- what should happen if the employee ceases to be employed; should they be allowed to keep or be required to sell the shares they own
- whether a shareholders' agreement is needed and if the existing articles of association are fit for purpose given the possibility that an employee will become a shareholder.