If you’re a small business chasing the next big idea, you’ll want to recruit and retain top talent. But how can you, the small business owner, hope to contend with established employers offering fat paychecks, fancy perks and job stability?
Offer your employees an opportunity they can’t get at a big corporate: the chance to own a piece of an exciting business they helped build.
What is an employee share scheme?
Employee share schemes offer employees the opportunity to acquire shares in their employer. Owning part of the business incentivises employees to stick with the business and help make it a success.
What types of employee share schemes are available?
Employee share schemes are broadly split into ‘approved’ and ‘unapproved’ schemes; a reference to whether they’re recognised by HMRC and so enjoy tax advantages.
There are four ‘approved’ share incentive schemes: Save As You Earn (SAYE), Share Incentive Plans (SIPs), Company Share Option Plans (CSOPs) and Enterprise Management Incentives (EMI).
Which employee share scheme is best for small businesses?
Small businesses looking to incentivise their employees by giving them shares in the business will generally want to adopt an Enterprise Management Incentive scheme.
This is because EMI schemes are flexible and one of the most tax advantageous options. With an EMI scheme, employers can pick and choose which employees are eligible to join the scheme and set their own rules on when employees can join the scheme and exercise their share ‘options’ (the right to acquire shares in the company).
What about the other schemes?
SIPs and SAYE schemes aren’t generally used by small businesses because they must be open to all employees. These schemes generally work better in larger, publicly listed, companies.
While employers can choose which employees CSOPs apply to, the tax advantages are less generous. CSOPs are often used where the employer isn’t eligible for the EMI scheme.
While a small business could put in place an unapproved scheme, expensive tax charges are likely to put employees off. If you’re thinking of an unapproved scheme, it’s worth consulting with an employment solicitor and your employees first.
Is your business eligible to offer an EMI scheme?
In order to offer an EMI scheme, your business must:
- be a company limited by shares
- be independent (ie not majority owned by another company)
- have gross assets of less than £30 million.
- have fewer than 250 employees.
- be a carrying on a commercial trade which isn’t an excluded activity (eg property investment, banking, insurance, professional services, etc)
- Employers can grant up to £250,000 of EMI options per employee and up to £3 million in unexercised options in total to all their employees.
Who is eligible to join an EMI scheme?
Employees who own less than 30 per cent of the shares in their employer and work there more than 25 hours a week (or for over 75 per cent of their working time) are eligible to join an employer’s EMI scheme.
How does the EMI scheme work?
Employees joining the scheme will need to sign a written agreement, following which they’ll be granted share options in the company.
Employers can choose when to grant share options, but this will usually be when a new employee joins the business or when the scheme is first created.
Employers can specify criteria employees must meet in order to exercise their options. This allows employers to implement things like performance targets and/or vesting provisions, ensuring employees can’t just take the shares and run.
What are the tax advantages of EMI schemes for employees?
Unlike unapproved schemes, there’s no income tax or national insurance when employees exercise an EMI option. Employees also enjoy a reduced rate of capital gains tax (10 per cent) on the sale of their shares. Here’s an example:
James is granted EMI options equal to 2 per cent of his employer’s share capital at a market value of £10,000. Three years later he exercises the option when the market value of the shares is £100,000. He receives £200,000 for his shares when the company is acquired two years later.
James pays no tax when he is granted the option or exercises it. When he sells the shares, James pays capital gains tax on the gain of £100,000 (ie the difference between the sale proceeds of £200,000 and the exercise value of £100,000) at 10 per cent. James pays just £10,000 in tax in total, banking £190,000 in cash.
If the scheme had been an unapproved scheme, James would have paid £68,500 in tax if he was an additional rate tax payer. A whopping £40,500 of this would have been payable by James out of his own pocket at the time he exercised the options (as he wouldn’t have received any cash yet).
What are the tax advantages of EMI schemes for small businesses?
The costs of setting up and administering an EMI scheme are deductible from taxable income for corporation tax purposes. This helps small businesses offset some of the costs of implementing an EMI scheme.
Employers can also deduct the gains employees make when exercising their options from their taxable income. For example, when James exercised his option above, his employer would have been able to deduct the £90,000 gain (exercise value of £100,000 less grant value of £10,000) from their taxable income.
How do you set an EMI scheme up?
Implementing an employee share scheme is complex and not something most small businesses can do alone. To ensure everything is done properly and that your scheme will qualify, it’s worth hiring a specialist solicitor or accountant. This is especially true if you’d like to include bespoke rules in your scheme.
How much does an EMI scheme cost to set up?
A simple EMI scheme with a couple of employees is likely to cost around £2,000 to £3,000 to set up in legal fees and remember, it’s tax deductible! Complex schemes for large companies with lots of employees will be more expensive.
Further reading on employee share schemes
