Attracting and retaining key talent when cash is tight

Using EMI options can be a really attractive alternative for start up and growing businesses, particularly where recruitment is challenging and the company can’t afford top level salaries.

When you’re on the journey to grow your business, you need to hire the best people to support you on your journey.  But for start-up businesses, winning the war on talent can be a real challenge, especially when cash is tight and salaries are super-competitive.

One great way of attracting – and keeping – top talent is to offer them some equity in your company.  This can deliver a strong and long-term motivational impact, aligning your employees’ interests with your own.  If and when your company is sold, employee optionholders have the opportunity to share in the value they have helped create.

Using a share option plan will usually be much more tax efficient than using cash.  Gains are typically charged at a 20% or even 10% rate, rather than the much higher income tax and National Insurance Contributions (NICs) charges that apply to salaries or cash bonuses.

Smaller, independent companies are best advised to use a very tax efficient, flexible option scheme called Enterprise Management Incentives (EMI).

• EMI uses options, not shares.  An option is, effectively, a promise to your employee that they can buy a share in the future, but at a price fixed today.  Options don’t give any voting rights or dividend rights, so you don’t need to worry about giving up any control, or sharing any dividend payments you might rely on as a founder.
• You decide at the outset when the employee can exercise the option and buy the shares.  It’s very common for EMI options to become exercisable only when a company is sold, which means that the employees with EMI options won’t ever have the right to vote on the shares or receive any dividends.  This is often called an “exit only option”.  (You can structure the EMI scheme differently if you want, but this is a typical approach for start up businesses.)
• If employees leave, you can ensure that the options lapse as soon as employment ends.
• You can attach extra performance conditions to the options, to make sure that your key staff are focusing on the targets that are most important to grow your business.
• EMI is discretionary, so you can grant options just to one key person if that suits you – or you can add more employees as your business grows.  You can decide exactly how much you want to give your employees, so you are always in control of how much equity you want to use in your share plan.

Tax efficient approach

EMI is very tax efficient, and doesn’t require any upfront payment from employees.

• When options are granted, there are no charges to income tax or national insurance contributions (NICs).
• Options are usually granted with an exercise price equal to the market value of the shares at the date of option grant.  When options are exercised, the employee pays the exercise price, and there is still no income tax or NICs to pay.
• For “exit only” options, the shares are then usually sold immediately.  Any increase in the value of the shares between the date of grant of options, and the date the shares are sold, is subject to capital gains tax (CGT).  CGT is usually charged at 20% but EMI options will usually reduce that to 10%.
• In addition, the company will usually benefit from a corporation tax deduction based on the increase in value of the shares.

Which companies can use EMI?

EMI is designed specifically for smaller independent companies, but your company can carry on using EMI as it grows.  You can grant EMI options as long as you employ no more than 249 full time equivalent employees, and your company has less than £30m gross assets.  Your company must be independent – not under the control of another company.  Most companies of this type will qualify, though certain trading activities are excluded (for example, companies whose trade is based on property ownership).

What next?

Setting up an EMI needs some expert input – for example, you will need someone to check that your company qualifies, draft the documents, and help you value the shares in your company.  A good adviser should also be able to help you plan how much equity to give away, and explain about managing exercise conditions and leavers.

The RM2 Partnership Limited is an employee owned specialist consultancy that works almost exclusively with privately held companies and can advise on how best to structure and operate an EMI to make sure they work best for the company, the founders, and the employees, and also to maximise tax efficiency.  If you’d like to speak to one of RM2’s specialists please Sarah on enquiries@rm2.co.uk.