The Top 5 reasons why EMI share option schemes go wrong
EMI schemes are an effective long-term growth driver when employees are suitably motivated, but why can they go wrong?
15 December 2022
Technology, Media and Telecommunications
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An Enterprise Management Incentive (“EMI”) scheme is a tax-advantaged HMRC-approved share option scheme. It works by granting an option to an employee to receive the right to a number of shares if particular exercise conditions are met at a future date.
EMI share option schemes are a great mechanism for attracting, rewarding or incentivising select key employees in a business.
When implemented correctly, they can bring significant financial benefits to individuals who have been awarded options, whilst incurring minimal tax liabilities, usually meaning a greater net cash benefit to the individual when compared with the income tax and National Insurance Contribution implications of a cash bonus equivalent.
See: Why should I implement an EMI scheme over a cash bonus?
As a tax advantaged scheme, they can also be an effective long term growth driver when employees are suitably motivated, and the scheme is aligned with company strategy.
With so many benefits, what are the key reasons behind why they can go wrong?
1. Communication
Business owners often put much thought, effort and financial cost into setting up an EMI scheme, but communicating the scheme is one of the most overlooked steps in its implementation.
If your staff are not aware of what a generous benefit an EMI option is, then how can they be motivated by it?
Whether this is an internal discussion or undertaken by a specialist such as ourselves, the scheme, its benefits and operation must be effectively communicated to be understood, so that the benefit can be fully realised.
2. Overcomplicating schemes
With so much flexibility in how an EMI scheme can be designed, it can be tempting to create ambitious exercise targets but, if the target is too much of a stretch then it can have a demotivating effect.
Therefore, it is important that there is an element of realistic ability to reach the targets/hurdles set and the options can be exercised.
Furthermore, an elaborate scheme with complicated vesting schedules tied to performance-related hurdles can end up being very difficult to measure and can take up thought and management time without a corresponding benefit.
Many employers also try to create separate share classes with varying rights attached to each class, which can be part of a careful planning to ensure that the shares will be eligible for EMI. However, it can also become a cumbersome administrative burden.
3. Giving away too little/ too much equity
Deciding how much equity to give away can be a difficult decision for most business owners.
Giving away too little equity can happen as a result of perceiving that the business is worth more than it actually is and can result in an employee disincentivised to work harder, as they do not think the reward is great enough.
On the other hand, giving away too much equity will dilute the owner's share and reduce their capital return without significantly incentivising the employees.
4. Compliance
There are a number of ongoing compliance requirements once an EMI share scheme has been implemented.
See: What are the ongoing compliance requirements after granting an EMI option?
It is possible that, on top of penalties being charged by HMRC, a sale can be held up when a due diligence exercise finds ongoing compliance requirements have not been met.
There is also a s.431 (ITEPA 2003) election opportunity where the shares are ‘restricted securities’ and acquired through an EMI scheme at a discount. The election must be entered into jointly by the employer and employee within 14 days of the share issue.
The effect of the election is effectively to ‘ignore’ the restrictions to pay a tax liability upfront on the full unrestricted market value of the shares, so that when the restrictions are ‘lifted’ no additional income tax and national insurance liability is due.
5. Not working with professionals
Share schemes are intrinsically complicated and tax law is also complex. Tax advisors and lawyers are qualified to understand and interpret the legislation to ensure you don’t get caught out.
Your usual accountant or a shares scheme platform may not have the experience or expertise to sufficiently assist in a scheme's implementation or compliance, which can lead to issues further down the line.
As experienced specialists in EMI and other share schemes, we are aware of the potential pitfalls and are also on hand to help if a scheme has gone wrong.
Don’t hesitate to contact a member of our tax team or your usual Bishop Fleming contact if you are looking for assistance with fulfilling your compliance obligations.
EMI share options
See also our other articles on EMI share option schemes:
