You’re an early-stage company looking to attract and incentivise employees but you can’t yet afford to offer them big salaries. So what’s the answer? A possible solution might be an EMI scheme. We’ll take a look at that.
Enterprise Management Incentive options, EMIs, are an attractive because they offer tax-advantaged and flexible incentives for companies and employees that meet the qualifying criteria. They’re geared towards smaller companies to help them with growth potential, recruitment and retention and they give the company, effectively, a cash-free way of paying them.
So, let’s hear more about them from a share plans specialist. Earlier, James Sullivan-Tailyour joined me by video-link to discuss the many benefits. I put it to James that they are a great tool to incentivise your staff:
James Sullivan-Tailyour: “Yes, absolutely. So, share options are a really useful way of incentivizing employees, particularly in early stage start-up companies where cash is hard to find and there are plenty of other uses that you need to put their cash towards, so, you know, investment and growing the business. So, share options are effectively a cash-free way of paying your employees because whilst it costs the shareholders of the business in dilution terms, there's no direct cash cost in issuing options over shares in your business. As well, the whole point of a share option scheme, typically, is to incentivize employees to work towards an exit, so a sale or a listing of the business, or any other type of exit scenario that the shareholders are working towards, and you're aligning their interests with the shareholders and giving them a slice of the upside in a potential exit scenario. So, for an early stage company they are very helpful on a number of fronts.”
Joe Glavina: “In the team’[s Out-Law article on this, James, you say the EMI share option is tax advantaged which makes it attractive, and it’s not risky.”
James Sullivan-Tailyour: “Yes, that's absolutely right. So, dealing with the tax advantages first. So, early stage companies, small companies, may well be able to benefit from something called the EMI or Enterprise Management Incentive regime and, if you fall within that regime, you can grant share options, or stock options which, when they are exercised, are not subject to income tax or National Insurance Contributions and all of the gain that's made by the option-holder is subject to capital gains tax and that's a very motivating and effective incentive, and a very tax efficient way of paying your employees. There isn't really a more efficient tax efficient way of granting equity to employees than via an EMI option scheme. So, it's always worth exploring, if you're an early stage company, whether granting EMI options is something that's available to you. But even if you can’t grant EMI options, share options generally are, as you say, Joe, a good way of incentivizing employees in a manner which should be broadly risk free for them because there is no obligation to exercise your options and pay the associated exercise price. It’s only if the share price increases, and the company gets to an exit event such as a sale or a listing, that the option holder can, at their choice, choose to exercise their option and effectively convert their option into equity which they can then sell, but they don't have to do so and so if the share price doesn't perform as well as expected and the exercise price is greater than the value of the shares, the option holder doesn't have to exercise the option and there's no requirement to pay anything until you make that decision as to whether or not you want to exercise. So, it's a sort of a risk free bet, if you like.”
Joe Glavina: “The risk profile of tech start-ups is very well documented - many fail - so are the share options safe in that event?”
James Sullivan Tailyour: “Well, if the company fails then no, the share options will be worthless because they are a right to convert into equity, or shares in the company, and if the company has failed then the shares won't be worth anything. But I think the key point is that the option holder has not had to pay anything to acquire that right to acquire shares in the company. So, yes, in the unfortunate circumstance where a company does fail then those options won't be worth anything but at least it's not an investment in the sense that you won't have lost any money other than, obviously, the time and effort that you may have put into the company over the two or three years that you might have been employed with them.
Joe Glavina: “I see the share plans team has a guide on EMIs and it mentions how share options are seen in a positive light by potential outside investors too. Is that right and, if so, why?”
James Sullivan-Tailyour: “Absolutely. Yes. So, it's entirely standard for an early stage company, or even mature companies, to have some form of share incentive arrangement that's available for selected employees and I entirely agree that actually it can be seen as quite a positive thing. Firstly, because it shows a level of maturity on the part of the company and investors, private equity backers, will often look to a company's incentivization arrangements, including share options, and it’s a good gauge of the level of sophistication and maturity of the business. But I also think that the other reason why investors like to see share options in place is because of that point I made earlier about alignment. If you are granting employees an opportunity to share in the upside that's achieved on an exit from a PE house, or investor’s perspective, that's a good thing because it shows that you're incentivizing and motivating your employees to achieve an exit at the best price possible and that's entirely aligned with what your investors want. They want to sell the business, or their interest in the business, at the best price they can achieve and, in the meantime, grow the business as much as they can and if employees own part of the company, through shares or options which are rights to acquire shares, then their interests are entirely aligned on that score. So, that's why investors regard share option schemes as a very positive thing to have in place.
James and the share plans team have put together a comprehensive guide explaining the various legal requirements which companies must satisfy in order for their share options to qualify as EMIs, who can participate, and so on. We have put a link to that guide in the transcript of this programme.
- Link to Out-Law guide on EMI Options