What is an EMI Scheme?
An EMI (Enterprise Management Incentives) Share Option Scheme is by far the most generous mechanism with which to award employees with equity in your company.
But first back to basics - what actually is an option? Well, instead of a share, where someone owns a part of the business outright - an option is the right to buy a share at a fixed price.
If your business has any revenue, or has raised any investment monies - it’s likely to have value - and if you just gave away straight shares in the business - that’s likely to lead to a pretty hefty tax bill for the individual - and with an asset they can’t sell to pay the bill!
That’s why we use options, which in the UK don’t attract any tax until they are exercised (turned into shares).
To create options, you’ll first need to create an Option Pool.
What is an Option Pool?
An Option Pool is a placeholder on your cap table - showing that the directors of the company to issue shares in the future to whoever they’ve offered options to.
This dilutes all of the other shareholders - and the size of the Option Pool is often hotly negotiated between founders and investors.
What is a Share Option Scheme?
A Share Option Scheme is how you actually give options out to employees, consultants or advisors and the rules on how they work - just like an employment contract.
The biggest part of the rules is outlining how the option holder earns their equity. Just like you wouldn’t give someone 4 year’s salary the day they joined - it doesn’t make sense to give someone some equity and let them leave tomorrow.
Types of Option Scheme
There are broadly three types of Share Option Scheme.
1. Time based vesting (earn over a period of time - say 4 years),
2. Milestone based vesting (earn only if certain defined milestones are hit)
3. Exit only (if the business is sold, they get some shares)
You can learn more about the different types of share option scheme, but at SeedLegals our strong preference, backed up by data from well over a hundred option schemes, is that time based vesting gets the best results for companies.
How to set up an Option Scheme
What’s the difference between an EMI and Unapproved Share Option Scheme?
An Unapproved Share Option Scheme is one for consultants and advisors whereas an EMI Share Option Scheme is for employees or directors working more than 25 hours a week, or 75% of their working time.The reason that they are treated differently is the UK government wants to help companies attract and retain the best talent and an EMI scheme maximises the potential profit for each option holder.
Part of an EMI scheme involves agreeing a valuation with HMRC, which fixes the strike price (that’s the price that someone pays for their option) at a low level and gives everyone certainty about what they own. Any upside from that point is taxed at the 10% entrepreneurs relief rate, compared to paying income tax and national insurance on all of it.
What is an EMI Valuation? How can I get a discount?
The EMI valuation is something that you propose to HMRC, using a VAL231 form. There are two numbers that you’ll need: First is the Unrestricted Market Value - ie what the shares are actually worth and the Actual Market Value - what the shares are worth, discounted for restrictions (e.g. the fact that the shares are vesting over time).
Because a lower strike price is beneficial for the employee - normally the objective is to try and agree as lower valuation as possible and companies often come to us asking to achieve the biggest discount possible. HMRC recently charged their rules to make this
We’ve recently created our automated valuation report tool - an incredibly sophisticated bit of technology that helps startups create a comprehensive valuation report, which works alongside HMRC’s new rules, that will help your scheme be approved in a fraction of the time and cost of using a law firm or accountant.
How can I register an EMI Share Option Scheme with HMRC?
All EMI schemes need to be registered with HMRC’s government gateway account.
This is a relatively simple process, where you let them know a couple of details about the scheme, after you’ve registered from HMRC services. But you’ll also need to let them know when you’ve granted options to individuals too, within 92 days of the paperwork being signed.
Also, every year in July you’ll need to complete an EMI Annual Return - to let HMRC know of any changes (e.g. any options have lapsed, or have been exercised).
How much does an EMI scheme cost?
The costs of an EMI scheme were historically hugely expensive. You would have to pay a law firm to draft you some scheme rules, an accountant to draft a valuation and afterwards you’d have no help managing the scheme with HMRC.
But at SeedLegals, we’ve changed that. With our platform you can create a completely personalised EMI scheme, set vesting conditions, have law firm quality (or better!) legal drafts, a market leading valuation and all of the ongoing management of the scheme, at a fraction of the cost of any other solution on the market.