UK startup's guide to EMI schemes

Here's another acronym to add to your equity vocabulary: EMI or Enterprise Management Incentives.

If you’re a startup founder in the UK, you’ve probably heard the terms EMI schemes more times than you’ve had to pivot your business model. We're here to help you understand how Enterprise Management Incentive Scheme works, in collaboration with our expert legal partners, Sprintlaw UK.

HMRC data shows an increasing number of startups are setting up employee stock options to attract new talent or retain, motivate and engage key team members.

Before we dive into the raft of benefits EMI scheme can provide, let’s explore the nuts of bolts of how they work.

What is an EMI scheme?

An Enterprise Management Incentive or EMI scheme is a way to grant equity (or ownership) to an employee.

In case you're wondering, yes, EMI schemes are the same as employee stock options. EMI is simply a term used by UK-based companies whereas ESOP is more commonly used in Australia and America. EMI, ESOP, ESOW — they all mean "stock options" or "share options". Don't be confused if we use these terms interchangeably!

Now that is settled, this guide is about setting up EMI options schemes in the UK.

At a high level, an EMI scheme works like this:

• the employee or contractor receives options (or rights) and becomes an option-holder
• who can be issued shares
• as long as they comply with the rules of the scheme

Benefits of EMI schemes

Benefits of EMI schemes abound for both the company and the employee receiving options. To name but a few:

Attracting talent. Whether you're in the UK or anywhere in the world, it’s no secret that cash can be tight for startups, which makes it hard to compensate talent. Using an EMI options scheme, startups can offer tasty equity incentives to top-up slightly lower remuneration packages. The same applies for attracting experienced advisors and developers at an early stage — knock their socks off with your idea, incentivise them with EMI options.

Retaining talent. It’s hard to attract top talent and even harder to keep it.EMI options are usually subject to vesting, which encourages them to see through it and stick with a company until the options vest. This is why this is often called “sweat equity” – team members need to put in the blood, sweat and tears in order to convert their options into shares.

Opportunity for significant employee financial gain. An employee can benefit from the increase in value of the options over the company lifetime. EMI schemes offer motivated employees the chance to generate real wealth through hard work, rather than an outlaying funds from their own pocket.

Tax efficient. EMI schemes can create significant tax advantages for the employees receiving options. More on this below.

Incentivisation. Potential ownership of a slice of the company means employees start thinking like business owners. It’s common to see a spike in collaboration, productivity, and innovation when EMI schemes are used to incentivise the team.

What type of EMI share option scheme should I set up

There are a range of tax efficient option schemes you can set up in the UK. Aside from EMI, options plans include:

• Share Incentive Plans (SIPs)
• Save As You Earn options schemes (SAYE)
• Company Share Option Plans (CSOP)

With that said, 85% of businesses in the UK that offer tax efficient equity schemes offer EMI. Clearly, EMI schemes are most popular for awarding equity to team members because it has the significant tax benefits. If your company is eligible, it’s usually the recommended option.

And for that reason we want to focus on EMI schemes in this guide.

EMI schemes, explained

So, are you eligible for an EMI scheme?

Essentially, the basic qualifying criteria that HMRC requires are the following:

• Your purpose for setting up an EMI scheme is to retain or recruit employees and not the tax advantages or to simply avoid tax.
• You should only intend to grant any one employee a maximum value of £250,000 in options.
• The most a company can grant is £3m in unexercised options at any one time.

A company then must meet the following criteria to be eligible to implement an EMI scheme:

• It must be independent. More than 50% of the ordinary share capital must not be owned or controlled by another company, either now or in the future.
• If the company has any subsidiary companies, they must also qualify for EMI schemes.
• The gross assets must not exceed £30m at the time of EMI options being granted.
• It must have fewer than 250 full-time employees.
• It must have a permanent residence in the UK.
• The business may not participate in one of the disqualifying industries which include financial activities, property development, farming, or shipbuilding.

Finally, employees (including Directors) must also meet criteria to participate in an EMI scheme:

• They must work at least 25 hours each week or devote 75% of their total weekly working time to the company.
• They must not have a beneficial or controlling interest, directly or indirectly, of more than 30% in the company, either now or in the future.

How is an EMI share options scheme taxed

Tax treatment can be a beast to get one’s head around, so we’ve broken it down for you as follows:

• Tax is payable on exercise (not upon grant or satisfaction of vesting criteria) where the exercise price is lower than the market value of the shares upon grant of the EMI options. Income tax is then payable on the difference between what is paid to exercise the options and what the options were worth when they were granted.
• Tax is not payable if the exercise price is equal to or greater than market value at the grant.
• Capital Gains Tax (CGT) is payable upon the sale of any exercised options.
• EMI legislation demands that any restrictions on shares acquired after exercise of EMI options must be set out in the EMI Option Agreement. If they aren’t, the Option Agreement can be deemed invalid and the employee may lose tax benefits.

The main benefit to the employee is not paying national insurance or income tax, as they would if they were issued shares outside of this scheme. It’s super important to follow the EMI legislation closely to make sure you don’t disqualify employees.

Other types of share option schemes

What other share option schemes and employee share schemes are available if an EMI is out of the question?

Save as you Earn (SAYE)

• Offers an option price up to 20% lower than market price.
• Employees can select a contract period anywhere between three and five years, where between £5 and £500 of their post-tax salary is saved.
• The money saved is used to buy shares at the option price they were offered.
• If the share price of the company has gone up, they make money from the option scheme.
• If the share price has decreased, they don’t lose any money, they just get all their savings back in full.

Company Share Option Plan (CSOP)

• Employee can buy shares up to £30,000 with no discount on the market value
• As a discretionary option plan, employees who otherwise wouldn’t be offered shares in the company are able to buy them.

Share Incentive Plan (SIP)

• A company can offer free shares, partnership shares, matching shares or dividend shares.
• Free shares allow the company to gift up to £3,600 worth of shares to each of their employees annually
• Partnership shares allow employees to buy shares of up to £1,800 from their pre-tax salary annually
• Matching shares can be matched to each partnership share an employee owns for the same amount

Dividends from previous years can be used to purchase new shares annually.

Frequently asked questions on setting up an EMI scheme

What documents need to be prepared?

The primary documents are Option Scheme Rules and the Individual Offer Letters to option recipients.

Cake has developed template documents using the UK’s best practice principles and baked them into our equity management platform. But if you need extra help with the legals, our legal partner Sprintlaw UK is always happy to assist.

Where do the options come from?

The company creates an ‘option pool’, setting aside options that can be allocated to employees or contractors. Consider this one slice of cake, from which smaller nibbles are then allocated.

The standard option pool size is 10% but it can vary between 5% to 30%. This is always a percentage of the ‘fully diluted’ capital in the Company.

An option pool can be created on a Cake account in minutes.

Do options need to be registered with HMRC after the grant. If so, when?

Yes. Within 92 days of the grant.

Is there a filing fee for registering EMI options with HMRC?

No.

How much will it cost to set up an EMI scheme?

Through Cake and with direct support from Cake's start-up legal partners, you can get a fully compliant EMI scheme set up for 3-4x cheaper than the usual cost. This cost will include getting your EMI scheme fully automated going forward, so there are no need for further costs each time you want to make an offer.

Who can provide the EMI approved option scheme valuation?

Only the HMRC can approve a valuation.

Any qualified accountant can prepare a valuation report, which then needs to be submitted to the HMRC to determine the final, approved valuation, which Cake’s expert partners can provide to its customers at special discount fixed fees.

What does the valuation report need to include?

The valuation report needs to include:

• Unrestricted Market Value (UMV): This values all the shares as if they had no restrictions and could easily be bought and sold at the market value company at the time. This figure is used to calculate the maximum amount of options allowable to be granted to an individual (£250,000) or by the company (£3m).
• Actual Market Value (AMV): This will not be higher than the UMV, but may be significantly lower. This is because any shares offered via an EMI will make up a small proportion of the company's total equity, and may not be ready for sale on exercise. The AMV is used to set the income tax point for the shares when they are exercised.

How much does a valuation report cost?

It will vary based on the company size and financials. Get in touch with Cake to be connected with a specialist valuer, who can provide a quote.

How will the process work?

You can file for valuation with HMRC, which takes between 2-4 weeks from start to finish.

If you file for valuation with HMRC you can be confident that the valuation is compliant and therefore provides certainty around tax treatment upon the exercise and sale of options.