Your comprehensive guide to EMI share options
In brief: EMI stands for Enterprise Management Incentive. This is a share option scheme backed by HMRC in the UK, designed for employees or directors working for more than 25 hours per week (75% of their time) in a business. Options are generally more beneficial than shares because no tax is paid when they’re granted – only when they’re exercised. EMI goes further by offering various appealing tax reliefs on exercised options for both the company and its employees.
In a nutshell, EMI is the most tax-efficient method of granting options to employees.
This guide will explain everything you need to know about starting an EMI share scheme, including:
Without further delay, let’s get started on our guide to the EMI Share Options Scheme…
Key Background Terminology
If you’re unsure about the terminology that surrounds shares and options, this short chapter will translate some of the common investment jargon. If you can already decipher this lingo, please do jump straight to our information about EMI share options. But here’s what you need to know first:
A share is a unit of ownership in a company or a financial asset. In most circumstances, the terms “stocks” and “shares” may be used interchangeably – though you may refer to your “stocks” as an asset whereby a “share” is when you’re referencing your ownership of a particular business.
There are two main types of share – Ordinary Shares and Preferred Shares. Ordinary Shares are usually those that a company starts out with at incorporation, whereas Preferred Shares are often given to investors when a company raises money, to give them extra protection on the money that they have invested. A common example of this protection would be granting investors Liquidation Preference, which allows them to be first in the queue to be paid if the company goes bankrupt.
Remember: in the context of this guide to EMI Share Options, we’re looking at how shares in a business can be owned by its employees – not the wider public market. Indeed, the world of stocks and shares goes far deeper than the brief explanation above, but this should give a useful baseline understanding.
Option / Employee Stock Option (ESO):
An Employee Stock Option (ESO) is offered by a business to its employees, and is the option to purchase a share at a fixed price (aka “strike price”) in the future.
The period between when you grant share options and when they can be exercised is called the “vesting period” – this can be time-based, target-based, or event-based – and can also be incremental (e.g. 25 shares after a year, and 25 more after 18 months).
In a nutshell, an ESO is an equity-based compensation incentive. It doesn’t attract tax when granted, and if the company grows and increases in value between when an option is granted and when it is exercised, the employee’s shares will simultaneously be worth more than they pay for them.
Share Option Scheme:
As you might imagine, a Share Option Scheme is created to grant options to staff. The main benefit of creating a scheme is to attract and retain the best talent, and to encourage long-term loyalty at an early-stage business. There are two main types of scheme: an Enterprise Management Incentive (EMI) and an Unapproved Option Scheme. These will be explained in detail later in this guide.
The Option Pool is the percentage of a company which is reserved for ownership by its employees. This is also called an “ESOP” – Employee Stock Option Pool. The percentage depends on the business, but in the UK the median amount of equity in the Option Pool is 10%. In the US, it’s closer to 20%. VC investors will usually expect a growing Option Pool to devalue the founders’ share of the business – not their own.
Unapproved & Approved Share Option Schemes:
Unapproved share options are important to understand in the context of EMI. An unapproved scheme is a share option scheme (as is EMI), but it requires no official involvement or pre-approval from HMRC. The company is free to structure the options scheme as they desire, but there are no associated tax benefits – aside from not being charged National Insurance or Income Tax when they’re granted.
An approved scheme is less flexible, because you must meet certain HMRC conditions to qualify. But approved schemes have significant advantages over unapproved schemes. We’ll explain these advantages later in this guide, focusing our attention on one type of approved scheme: the Enterprise Management Incentive (EMI). Other approved schemes include Company Share Option Plans (CSOP), Share Incentive Plan (SIP), and Save As You Earn (SAYE).
In Detail: What is an EMI Share Options Scheme?
As we outlined in the introduction, an EMI Share Options Scheme is an initiative by HMRC that allows UK businesses to give share options to their employees with significant tax benefits.
This scheme is intended to help smaller independent businesses realise their potential by attracting and retaining the best employees for long-term success. In practice, the key difference between EMI and unapproved schemes is that HMRC will approve a valuation and fix a certain strike price. And of course, there are other conditions for businesses and employees to meet, which we outline later in this guide.
The EMI valuation is something that you propose to HMRC via the VAL231 Form. You’ll need to calculate two key numbers for this proposal: the Unrestricted Market Value (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). Remember, you’ll want a low valuation, because the profit will then be greater for your employees when the value of the shares increase over time.
Important note: The SeedLegals automated valuation report tool will help your startup create a full valuation report, which adheres to HMRC’s rules and helps your EMI scheme be approved in a fraction of the time and cost of using a law firm or an accountant. Sign up here.
The Benefits of an EMI Share Options Scheme
What are the benefits of Share Options for employees?
For employees, options don’t attract tax until they’re exercised. This lack of upfront payment generally makes them an appealing way to secure equity in the business they work for.
When unapproved options are exercised, they attract Income Tax and National Insurance (NIC) on the difference between the market value and the amount the employee pays – in essence the discount is seen just like a salary bonus. EMI options are more beneficial – with no Income Tax or National Insurance due on the difference between the HMRC-approved valuation (actual market value) and the value of the share when exercised.
After obtaining shares, the holder is subject to Capital Gains Tax (CGT) on their disposal, but EMI option holders can claim Entrepreneurs’ Relief – reducing the rate to just 10%. In contrast, unapproved option holders will have to pay regular Capital Gains Tax unless they own more than 5% of the company.
What are the benefits of Share Options for business?
The benefits of an EMI Share Options Scheme are wide-ranging for your business. Financially, you’ll enjoy a Corporation Tax (CT) deduction equal to the difference between the market value of the shares at exercise and what your employee pays for them. When the exercise price is equal to the value, your CT deduction equates to what would have been taxed without the EMI Scheme relief. If you’ve granted options at a discount, you’ll get CT relief for the discount and what would have been taxed without EMI.
But the benefits for your business go deeper than Corporation Tax relief. Here are more key advantages:
Attract talent: Offering a rewarding option scheme will attract the best talent in the jobs market, which is especially important for startups and early-stage businesses battling to grow in competitive industries. Indeed, options are fast becoming a must-have and expected “perk” in the tech startup world.
Retain talent: Depending on the conditions of your options scheme, it keeps your employees focused on medium-to-long-term growth and sustainable success. The options must be exercisable within 10 years, and most businesses allow exercise far sooner (e.g. 2-3 years).
This creates a magic combination of ownership and foreseeable payoff – a powerful motivator for staff to work through challenging periods and keep faith in the potential of the business. In most cases, options are lost if the employee leaves, so the EMI Share Option Scheme helps you nurture your highest performers for senior management roles.
Align interests: If the company succeeds, the employees with EMI options will enjoy a significant financial reward. Staff can see the value of their shares increase as the business grows, which is a tangible signifier of progress. The whole team can then be aligned to generating a profitable exit. This also helps staff feel valued, trusted, and involved in building a strong company.
Reward employees: EMI options can be offered as a reward for meeting certain individual or company targets. This provides an incentive for staff to go the extra mile, and it can provide a performance-based reward which doesn’t impact cash reserves and at the same time creates tax benefits for all involved.
EMI vs. Unapproved Options Schemes: Comparison Examples
A company offers their employee, Jane, an option to secure 5% equity for a market value of £10,000. Later, she exercises this option when her shares are worth £100,000. As with any options scheme, there was no tax to pay when the options were granted, but when they were exercised they were seen by HMRC as taxable earnings – meaning Jane was responsible to pay tax on the £90,000 difference.
This would be higher-rate Income Tax (40%), meaning a £36,000 tax bill despite not having seen any of the cash. When the company is sold 18 months later, Jane sells her shares for £125,000. This is a £25,000 increase in value from when she acquired the shares, and 20% Capital Gains Tax will be due on this – meaning an extra £5,000 bill.
In total, despite acquiring shares for £10,000 and selling them for £125,000, Jane has paid £41,000 in tax. What’s more, £36,000 of this is due before she actually has her hands on the cash – which leaves her very vulnerable in the case of a sudden collapse in share value.
EMI Options Scheme:
Sarah is offered the same equity for the same value within a different EMI-qualified business, and she also acquires her shares worth £10,000. However, exercising her options incurs no tax bills whatsoever, and when she later sells her shares for £125,000 she is entitled to Entrepreneurs’ Relief; the reduced rate of 10% on Capital Gains Tax. This means that Sarah will now pay CGT on the £115,000 value increase between what she paid for the shares and what she sold them for: 10% = £11,500.
So, Sarah will pay £11,500 total tax (when she has the cash), while Jane pays £41,000. The EMI Share Options Scheme would therefore save more than 112% for the employee in this circumstance. This shows why EMI is so popular, and why it is a must-do for growing startups and small businesses.
Important note: As we mentioned earlier, Sarah would also benefit from a HMRC valuation which is as low as possible. This allows her to get the options at a lower strike price, thus maximising her profit when the company shares are eventually sold.
Read our companion article: EMI or unapproved share option scheme; which one is best for you?
Conditions for EMI Qualification:
- The business must be actively trading and have permanent establishment in the UK
- The business must have fewer than 250 employees when the EMI options are granted
- The business’s total assets must not be worth more than £30 million
- The business must have allocated less than £3 million in EMI shares
- The business mustn’t be a subsidiary or be externally controlled
- The business must notify HMRC within 92 days of granting the options
To learn more about whether your company qualifies for an EMI Share Option Scheme, check out our article: Does your company qualify for an EMI Share Option Scheme?
- The person must be a legal employee of the business
- The person must use a minimum of 25 hours per week, or 75% of their time as an employee or director of the company
- The person cannot hold more than 30% of all company shares
- The market value of the options mustn’t exceed £250,000 per employee
- The options must be granted within 90 days of HMRC’s valuation
- The options must be able to be exercised within 10 years of being granted
- The options must be non-transferrable
All terms and conditions for your option scheme must be placed in writing. Aside from the HMRC rules, all other terms are flexible and can be designed by your company. These include vesting periods – i.e. when the options can be exercised (events, achievements, or timescales within 10 years).
How to Set Up an EMI Options Scheme
Traditionally, setting up an EMI Option Scheme was expensive: it could cost up to £5000 – £10,000. You’d need to hire a law firm to draft the scheme rules and bring an accountant in to draft a valuation for submission to HMRC. And for schemes with more than 50 employees, you’d be looking at £10,000 – £20,000. This could take months and you’d be on your own when managing the scheme with HMRC.
SeedLegals has changed all this. Using 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 get help with all the ongoing management of the scheme. This comes at a fraction of the cost of any other solution: a £1,500 flat fee for scheme setup, and a £1,000 flat fee for your EMI valuation.
Book to speak to an expert to start your scheme.
What Will You Need to Set Up an EMI Options Scheme?
You need a lot of documentation to offer employees EMI options. Until recently, you had to track them in your own complex Excel spreadsheet. But now we’ve got you covered. Here’s what we provide:
Option scheme rules: An EMI scheme needs rules, outlining what the vesting provisions are, what happens during an exit, and how employees are handled when they leave. SeedLegals gives you a fresh set of rules designed for your own needs – not a vague template.
HMRC filings for your company valuation: Once you have your scheme rules, you need to agree your valuation with HMRC (more on this below). You can stick with your previous funding round valuation if you have one, but you’ll need to send a VAL231 form to HMRC to be certain of future tax treatment. SeedLegals automatically creates this documentation for you.
Valuation report: If you want to get a lower valuation than your last funding round, or if you’ve never done a funding round, you’ll need to create a valuation report for HMRC. SeedLegals produces an expert report in a fraction of the time and cost of an accountant to help you achieve the optimal valuation.
Grant paperwork: Once you have an approved HMRC valuation, you can send out option agreements to your employees. Our platform makes this a breeze. In just a few clicks, you can specify who you’re granting options to, how many options you’re granting, and what the conditions are. We’ll create the grant paperwork for the company and the employee, and you can even sign it with an e-signature.
EMI notifications: You need to tell HMRC about EMI your options grants (a “notification”) within 92 days. Late filing charges can quickly add up. But with SeedLegals, you can instantly export the filing and upload it to your HMRC account.
EMI Annual Returns: In addition to the notifications (mentioned above), your company will need to complete an Annual Return. We provide you with a reminder, and what you need to file and when.
Option tracking: As your team grows, it gets harder to figure out exactly who has what, what’s vested, and what’s left to vest. But once you’ve granted options, you’ll have access to our beautiful dashboard, which shows you exactly how many options are outstanding, vested and exercisable. No more Excel.
Exercise of options: To cap it off, once an option is exercisable and the holder chooses to exercise it, the platform can create a notice of exercise (effectively the holder saying they are converting into shares now), and even create the SH01 for the company to file with Companies House.
How to Set Up an EMI Options Scheme Using SeedLegals
The below video shows you how easy it is to set up an options scheme using the SeedLegals platform:
And here’s a written step-by-step guide to creating an EMI Options Scheme for your business using the SeedLegals platform, including what you need to do to keep HMRC happy with your scheme:
Step 1: Create agreements for your team members, promising share options to them in writing – with a vesting schedule and “Good & Bad Leaver” provisions.
Step 2: Create an Options Pool with sufficient options for current and upcoming team members.
Step 3: You may need to update your Articles of Association to support options, but this isn’t always the case. We will let you know.
Step 4: On your SeedLegals dashboard, click to create your EMI Options Scheme on SeedLegals.
Step 5: Define your Option Plan. The SeedLegals platform will take you through this step-by-step.
Step 6: Complete and agree your company valuation in conjunction with our accounting partner. Not to worry, it’s all included in the SeedLegals package. Here’s a video to show how it works:
Step 7: Submit the VAL231 to HMRC Shares and Assets Valuations (SAV) with your backing documents, and wait until they respond. This will usually be within 4 weeks of submission.
Step 8: After the HMRC response arrives, it’s time for you to agree or haggle with their valuation. Their decision holds for 90 days, after which time you would need to resubmit your documents.
Step 9: Pass resolutions and grant options to team members within 60 days. You can issue these with beautiful options certificates, which the SeedLegals platform will help you create easily. Here’s another short video to demonstrate how this works:
Step 10: You must formally register the scheme with HMRC, and notify them about granting the options to team members within 92 days of the grant date.
Step 11: If you haven’t done so already, register for PAYE online – and then register your options scheme through PAYE online.
Step 12: Add individual option holders to the scheme. Any further option holders added to the scheme need to be notified individually within 92 days of their grant. And as we mentioned earlier in this guide, SeedLegals enables you to automatically download the documents you need for HMRC notification – and you can upload them straight to your HMRC account.
Step 13: Don’t forget to file your EMI Annual Return by 6 July every year. You will incur an automatic penalty fine if these documents arrive late. SeedLegals will send you a reminder.
Note: You can get prior clearance from HMRC by supplying supporting documentation to confirm that you do indeed qualify for the EMI scheme – before committing to paying for the valuation process. SeedLegals can submit this Advance Assurance for you, but for most companies this isn’t required.
Your EMI-qualified status could be changed if a disqualifying event happens. Examples of disqualifying events include the following:
- The company ceases to actively trade or stops for more than two years after the grant
- The company becomes controlled by another entity (i.e. less than 50% controlled)
- The employee ceases to work for the company or reduces their work to less than 25 hours or 75% of their working time
- The employee holds more than 30% of the company’s shares or holds options worth more than £250,000 at the time of the grant
- Significant alteration to EMI option terms and/or company share capital
- The company grants a Company Share Option Plan (CSOP) to an employee, resulting in the individual EMI limit to be exceeded
- The company starts to work in one of the restricted / excluded activity areas
If a disqualifying event occurs, the employee’s options must be exercised within 90 days of that event. Failure to do this means that value gains between the disqualifying event and date of exercise will be taxable. Essentially, the option then becomes an unapproved share option.
If the event happens within 12 months of the options being granted, the employee will lose the Entrepreneurs’ Relief benefit of a reduced 10% rate of Capital Gains Tax upon the share’s disposal. Naturally, this relief is also lost if the options aren’t exercised within 90 days of a disqualifying event.
If your company grows to more than 250 employees or to have over £30 million in assets, it won’t be seen as a disqualifying event – but would prevent you from granting EMI share options in the future.
Important EMI Dates & Timescales to Remember
- It might take HMRC 4 weeks to respond to your valuation report
- HMRC’s valuation is valid for 90 days, so you need to grant options within that time
- Employees have 7 days to sign their options agreement and return it to your company
- You must register the scheme with HMRC, and notify the granting of the options within 92 days
- Your EMI Annual Return must be submitted by 6 July every year
What’s the best way to set up your EMI or Unapproved option scheme?
On SeedLegals we’ve automated all this. Simply sign up and create your company. We’ll help you choose the right option scheme for your team, show you the best option vesting and exercise terms for your company and team, and walk you through every step of the process. And, the SeedLegals platform will create all the documents, including the scheme rules, option grants, option certificates for team members, tax elections, and more.
Our team are on hand to answer any questions, start a chat with one of our options experts or book an option scheme design call.