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How to set up a share option scheme to incentivise employees

Turner Little- option scheme to incentivise employees

Retaining and incentivising key employees should be a priority for small and medium sized business owners. And one of the best ways to effectively do so is through a share option scheme.

Share options are tax efficient for both the employees who will benefit, and the company itself, making them a sensible option. However, it’s important to understand the ins and outs of share option schemes before committing, in order to achieve the best outcome. Here’s what you need to know.

How to get the most out of a share option scheme

The most commonly used share option scheme is the Enterprise Management Incentive (EMI). When a start-up is established, the owner will offer employees share options under the EMI scheme. Usually, employees can only use the share option when the company is sold on. This means they don’t have any other rights as shareholders other than to receive the value when it’s sold, thus incurring no direct cost to the business or its owners.

If the EMI scheme is implemented effectively, employees are able to pay capital tax (rather than income tax) on the money they make after the sale of the shares. They also might be able to claim entrepreneur tax relief, which will reduce the capital tax they owe.

The company itself is able to claim a deduction in corporation tax for the cost of this scheme, as well as the extra market value of the shares over the amount paid by its employees.

Does the EMI scheme work for all small businesses?

The EMI scheme only incentivises employees who buy into it. Therefore, a small business must also include other incentives for employees who don’t wish to do so. These could include other share option schemes, or types of bonuses.

If the key employees aren’t full time employees, and instead work as contractors, freelancers, work for less than 25 hours a week then they aren’t eligible to benefit from an EMI scheme.

Other schemes offering tax advantages include a company share option plan (CSOP), which is similar to EMI. Alternatively, the company could implement share incentive plan (SIP) or a Save As You Earn (SAYE) scheme, both of which have very different structures.

Rules and regulations for share options

Before a small business can implement a share option scheme, the shareholders’ agreement and any articles of association must be checked. If they don’t allow for the adoption of such a scheme, then they must be formally amended.

In addition, there are statutory requirements:

  • The company must have a turnover of less than £30 million.
  • It must have fewer than 250 employees (full-time).
  • It must be independent, which means it can’t be a subsidiary of another company or controlled by another company.
  • Any subsidiaries must be at least 51% owned.

The company also has to introduce clearly communicated rules so that everyone knows the ins and outs of the share options scheme. This should include the following:

  1. A clear explanation of when the share option can be exercised. For example, whether it is after a certain number of years, or only when the company is sold.
  2. The conditions that apply to exercising the option for employees.
  3. When the share option should lapse if the employee leaves the company.
  4. What happens should the company undergo a formal reorganisation.
  5. What the existing shareholder protections are.

James Turner, Managing Director of Turner Little Limited says: “A share option scheme valuation should also be sought so that taxation on the exercising of the option can be clarified. EMI options also have an individual limit that can be held by a single employee. Therefore, it’s necessary to agree the market value of the share options with HMRC.

“We would always advise getting professional assistance when setting up an EMI share option, as there are various complexities that must be understood in order to implement the scheme effectively. Share option schemes like this can be essential for unleashing a company’s potential, and to give valuable employees a valuable exit option.

“However, not every company will benefit from an EMI scheme, and it is necessary to thoroughly analyse the company’s needs before selecting the appropriate share option scheme.”

About Turner Little
Founded in 1998 in Yorkshire, UK, Turner Little is a specialist UK and offshore company formation, banking and corporate services provider. Our services include company formation, UK and offshore banking, asset protection, credit correction, trademarking and trusts. Other services include Internet services, mail forwarding, wills and probate. Turner Little’s vision is to offer the best possible service, together with market leading products.

Turner Little and its affiliates do not provide tax, legal or accounting advice. Material on this page has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.