Key to the success of any video games company is the recruitment, retention and motivation of employees who can help to make a success of the business they work for. In a sector where the battle for talent is fierce and where, particularly for early stage companies, paying competitive salaries is a challenge, employers need to identify low cost ways of attracting and incentivising key people.
One of the ways in which this can be done is through offering employees an equity (or share) interest in the games company they work for. In addition to the employee-relations benefits that a share interest can bring, the growth potential of games companies makes them ideal for using share incentives with significant employee upside on offer.
One way in which equity interests can be provided is through the Government backed Enterprise Management Incentive option scheme or EMI.
How does EMI work?
EMI has the following key characteristics:-
- employees are given (or “granted”) an option (an up-front right to acquire shares) with that right being triggered (or “exercised”) on certain future conditions being met (to match the desired business goals);
- the employee can buy the shares on exercise for a price equal to their market value when the option is granted; with the incentive being for the employee to maximise the growth in value of the company (and thus his/her underlying share interest between grant and the ultimate sale of the shares under option);
- the employee incurs no up-front cost on being granted the option and there is no downside risk to the employee;
- on exercising the option, the employee becomes a shareholder and (in many cases) can then realise value from the shares on a liquidity event (a sale/listing); and
- due to the Government’s desire to promote EMI, employees are usually taxed at between 0%-10% on the growth in value of their interests (depending upon the gains in question).
The benefits of EMI
EMI offers the following advantages:-
- flexibility in design; with the ability to include retention and performance linked conditions;
- relative ease of implementation with many EMIs being implemented within 5-6 weeks;
- an opportunity to articulate business goals and align employee and shareholder interests; and
- significant Government backed tax breaks both for employer and employee.
How much more tax efficient is EMI?
Companies and participants in EMI both benefit from generous tax breaks.
A cash bonus of £50k will return just £29k to the employee at an overall cost to the employer of between £45.5k to £57k and with an overall efficiency (benefit: cost percentage) of between 51% to 63%.
£50k’s worth of gain to an employee via the sale of shares from an EMI option will return over £46k to the employee for an overall cost of £40k, leading to an efficiency rating of 115%!
As is always the case for Government backed tax incentives, there are some qualifying criteria to be met in order to benefit under EMI, including limits on the company’s size and employee numbers at grant. The EMI company must also not be controlled by another company and must carry on a qualifying trade. Participating EMI employees must also provide sufficient time to the business of the company and may not be a material shareholder (30% or more) in the company already.
What are the EMI limits?
As an incentive that is targeted towards growth companies, EMI is subject to certain limits on option values at grant but importantly with uncapped upside. In most cases the EMI limits provide ample scope for growing video games businesses to grant meaningful tranches of options to key employees. Each employee can hold EMI options worth over £250,000 of shares (valued at the date of grant). Due to HMRC’s favourable approach to valuing EMI shares, this could give in the region of up to £1 million worth of shares per individual! Companies may only grant EMI options in aggregate worth up to £3 million (again valued at grant) – again providing significant scope for substantial grants.
Key design issues
Due to its flexibility, EMI can be designed to meet the required business goals for the games company in question. Some of the key decisions that a company implementing EMI will need to make include:-
- who should participate?
- what should the aggregate EMI pool be for all participating employees and what should individual allocations be to employees out of that pool?
- when should the options become exercisable and the employee be capable of becoming a shareholder? Typically in games companies, exercise is based on achieving a liquidity event or on continued service for a set period of time; and
- what should happen to employees who leave prior to the options becoming normally exercisable?
We act for a number of games companies in establishing EMI and other employee incentive arrangements. For more information on how we can help, please contact John Dormer at email@example.com or on 01926 884626.