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When is the right time to set up an EMI option scheme?

Published: 
Nov 26, 2020
Updated: Apr 21, 2023
Tommy Hackley
Writer
Tommy Hackley

Senior Account Manager

Meagan Snopkowski Circle250
Writer
Meagan Snopkowski

Senior Options and R&D Specialist

Suzanne Worthington
Editor
Suzanne Worthington

Senior Writer

At SeedLegals, founders often ask us: when is the perfect time to put in place an EMI option scheme?

Many founders also tell us that they know they need to get their option scheme up and runningโ€ฆ but itโ€™s something theyโ€™ll get round to doingโ€ฆ eventually.

Your number one priority might never be to set up your EMI option scheme (unless your staff start leavingโ€ฆ). But if you get your EMI scheme set up sooner rather than later, you not only help to build a positive, collaborative culture in your company but also create significant financial benefits for option holders and your company.

Weโ€™ve helped thousands of companies with setup and legal support for their EMI scheme. In this post, we explain whenโ€™s the right time to set up your EMI scheme, based on what weโ€™ve discovered over the years from working with thousands of founders and investors.

The 3 triggers to set up your EMI scheme

Most founders understand the power of offering options to prospective employees when recruiting and retaining talent. Granting options helps to align your employees with the founders and investors for the long-term, and makes sure everyone has an incentive to work hard towards a successful exit.

But to set up an EMI option scheme, at what stage does your startup need to be? The right time is different for different companies โ€“ it depends on your revenue, how many full-time employees you have at the moment, and your plans for hiring and fundraising over the next year.

These are three triggers which could mean itโ€™s the right time for your company to set up an EMI option scheme:

๐Ÿ“ˆ Gained traction
or
๐Ÿ’ฐ Raised funds
or
๐Ÿง‘โ€๐Ÿคโ€๐Ÿง‘ Started growing your team

With more and more startups offering options to employees, people joining your team are likely to want/expect options on top of their annual salary, so they can share in the long-term success of the company.

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When it is the right time to grant EMI options, you must have a valid EMI Valuation

The EMI Valuation is the โ€˜market valueโ€™ of your company which you agree with HMRC to determine the exercise price of the EMI options.

For an EMI scheme, the EMI Valuation is non-negotiable: to be able to grant your employees EMI options, you must have a valid EMI Valuation at the time you grant the options.

Unlike the valuation you want when youโ€™re fundraising, companies want the EMI Valuation to be as low as possible so that you and your option holders get the best possible value.

The good news here is that HMRC accepts arguments to lower the market value of a company. Why? Because the purpose of EMI schemes is to help smaller companies โ€“ which canโ€™t match the big corporate salaries โ€“ to reward, retain and attract employees.

And donโ€™t worry โ€“ your EMI Valuation exists in its own EMI vacuum, solely for the purposes of granting EMI options. It canโ€™t be used for accounting or any other purpose. And you donโ€™t need to share it with anyone.

At SeedLegals, we have a sophisticated valuation methodology to help to drive down your EMI Valuation. You answer a straightforward questionnaire, and from that our advanced algorithm builds your EMI Valuation report based on your companyโ€™s financials, last price per share paid, and other factors. We take into account the unique situation of your company, weighting all the factors as appropriate, to create your EMI Valuation report, aiming to help you achieve the best possible EMI Valuation discount.

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Usually, itโ€™s best to set up an EMI scheme before a funding round

When youโ€™re setting up your EMI Scheme, as part of the EMI Valuation, HMRC will agree the strike price for your EMI options. (The strike price is how much your option holders will pay when they โ€˜exerciseโ€™ the options โ€“ that is, turn them into shares.) The strike price is based on:

  • The price per share of your companyโ€™s previous funding round

or, if your company hasnโ€™t done a funding round involving the same class of shares as the options:

  • Your companyโ€™s financial status

A key input for your EMI Valuation is your companyโ€™s share transactions โ€“ which are publicly available on the Companies House website. When weโ€™re setting out our proposal to HMRC for your EMI Valuation discount, if youโ€™ve done a funding round, this can greatly increase the starting point for your company valuation. We still aim to help you secure a big valuation discount โ€“ but an 80% discount on a valuation at ยฃ1 per share is going to lead to a much lower EMI Valuation than an 80% discount on a valuation at ยฃ10 per share.

Tommy Hackley

The discount on your EMI valuation is why for many companies, setting up an EMI Scheme before a funding round is best. Itโ€™s better value for the options holders, and a bigger Corporation Tax break for your company later on.

Tommy Hackley

Senior Account Manager,

SeedLegals

    Your future buyer knows that EMI schemes turn into big tax breaks

    One of the tax perks that comes with EMI schemes is the Corporation Tax relief for the company. And for a future buyer of your company, this could be very enticing. Hereโ€™s how it works:

    When employees exercise options, you can claim relief worth the difference between the exercise price and the market value of the shares. The bigger the difference, the more Corporation Tax relief the company gets.

    Hereโ€™s an example:

    • You grant EMI options with an exercise price of ยฃ0.01
    • At exit, your option holders exercise their options. The market value for the shares is determined by how much the buyer is paying. Letโ€™s say itโ€™s ยฃ15 per share.
    • The ยฃ14.99 is deemed as lost earnings for your company โ€“ and you can claim it as Corporation Tax relief.
      Whatโ€™s going on here? The way HMRC sees it, your company could have sold those shares for ยฃ15 on the market, but instead you sold them to your employees for just ยฃ0.01.
      So you can claim Corporation Tax Relief on ยฃ14.99 multiplied by the number of share options that are exercised.

    With EMI schemes, companies tend to grant more options when the equity is less valuable. And this can turn into a hugely valuable asset: youโ€™ll be sitting on the potential for Corporation Tax relief worth thousands of pounds. In fact, itโ€™s such an incentive for a potential buyer that founders usually put this detail on the Heads of Terms document when negotiating a sale.

    Just closed a round? Set up an EMI scheme fast

    If you donโ€™t have employees before your funding round and you plan to hire people after fundraising, then you could wait until after your first round.

    But thereโ€™s a catch. If you wait too long after your round, your valuation will go up as you use the money you raised to continue building traction. And it will become more difficult to argue for a lower valuation with HMRC.

    Often we see a surge in recruitment after a funding round. If youโ€™ve just closed a round and were planning to set up an EMI scheme but havenโ€™t got around to it yet, then no problem โ€“ but aim to get this done before recruiting.

    In fact, for companies that close their round and then set up an EMI scheme on SeedLegals, the average time to do this is just one month and 21 days. โšก

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    At SeedLegals, we set up 1 in 4 EMI option schemes โ€“ thatโ€™s more any other provider. When you set up your option scheme with us, our team is on hand to guide you at every step and provide the legal support you need for the EMI scheme. Weโ€™re here for ongoing unlimited support and your staff get their own option holderโ€™s dashboard to log in and view their options, vesting schedule and how much their options might be worth.

    Got questions about setting up an option scheme or the legal documents you need for EMI? Book a free call with our experts to get answers fast and find out why weโ€™re the UKโ€™s #1.

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    Tommy Hackley

    Tommy Hackley

    Equity strategist Tommy loves to use his legal background to help founders incentivise their teams with equity.
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