EMI are government-backed employee share options which allow companies to grant rights to employees to acquire shares. There is flexibility over the shares that are put under EMI options and therefore it is perfectly feasible to grant EMI option schemes over Growth Shares.
Growth shares reward employees for delivering growth in company value by enabling employees to share in a proportion of that future growth. Growth Shares help to protect existing shareholders from dilution by ring-fencing current value for them and are therefore an effective anti-dilution tool.
EMI allows companies to grant options (i.e. rights to acquire shares) to qualifying employees on a highly tax efficient basis for both the employer and participating employees.
Growth Shares are, in essence, a separate class of incentive shares which entitle participating employees to share in a proportion of the future growth in value of a company. In most cases, a further hurdle is also set (often slightly in excess of current value) at which point the employees’ Growth Shares become entitled to share in value.
There is significant flexibility in relation to the class of shares over which EMI options can be granted. As a result, EMI options can be granted over Growth Shares to benefit from the commercial and tax benefits of both arrangements.
EMI can be used by both private and smaller listed companies alike and either for targeted grants to specific key employees or on a wider (even all employee) basis. EMI options can be granted over UK or overseas company shares, provided that at least one company in the relevant group has a UK permanent establishment. Certain other requirements must be met by both the company and the employee in order for options to qualify as EMI options, such as a limit on a company or group’s gross assets through to the employee working at least 25 hours a week (or at least 75% of his or her overall paid time).
EMI options can be designed to meet a company’s business goals. As a result, EMI options can be designed to enable employees to become shareholders in the short to medium term. In such a case, employees may (if the company wishes) benefit from dividends and other shareholder rights.
More typically, however, employees will only receive economic benefits from their Growth Shares on an exit or other realisation event to the extent that the hurdle is exceeded. At that time, the EMI options will become capable of exercise and the employees can acquire their Growth Shares by paying the option price for them. They will then immediately sell the Growth Shares to the acquiring company and may benefit in a proportion of the exit proceeds to the extent that they exceed the Growth Share hurdle.
From an existing shareholder perspective, Growth Shares help to manage any dilution of existing value and motivate key employees to generate future growth for the benefit of Growth Shareholders and existing shareholders alike. They therefore play a key role in aligning shareholder and key employee interests.
Using EMI options is also very clean from a shareholder perspective with the forfeiture of EMI options being easily given effect to in required circumstances (i.e. leavers). Performance and/or time based vesting conditions can apply to EMI options to link reward to performance and/or length of service.
From the employee’s perspective, EMI options over Growth Shares offer potential cost efficiencies. Due to the lack of economic entitlements of the Growth Shares when the EMI options are initially granted, their market value should be relatively low, reflecting the fact that they have “hope value” only. This should result in HM Revenue & Customs agreeing a low market value for the Growth Shares and enabling a low option price to be set for the EMI options. The cost (or tax cost) to employees of acquiring their Growth Shares is therefore reduced.
EMI options over Growth Shares confer significant tax benefits on both employers and employees which can result in:
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EMI also allows companies to obtain agreement from HM Revenue & Customs (“HMRC”) as to the valuation of the Growth Shares under option – providing tax and valuation certainty to the company and employees alike.
Growth Shares require a new class of share and may not be feasible in all cases. Care must also be taken if the company has or is looking for investment via the Seed Enterprise Investment Scheme (“SEIS”) or Enterprise Investment Scheme (“EIS”) as Growth Shares cannot have lesser dividend and/or winding-up rights than the SEIS or EIS Shares.
As an HMRC tax favoured arrangement, there are certain qualifying conditions to be met in order for companies and employees to qualify under EMI. Some of these can be restrictive, although in cases of doubt HMRC can be approached for pre-clearance.
Although granting EMI options can be done with relative ease, there are a number of post-grant pitfalls that need to be borne in mind.