Employee ownership is a flexible succession solution that enables businesses to remain successful beyond the retirement of the business’s owners. This form of ownership succession is usually secured by transferring at least the majority of the shares in the company to an employee ownership trust (EOT), so that the business legacy can be continued by the people who know the business best: its employees.
Beyond the use of an EOT, the employee ownership model can be tailored around the needs of individual companies, the exiting owners and their employees. Exiting owners can retain elements such as ‘golden shares’ to secure their creditor rights and can hold on to a minority stake of legacy shares if they wish. For employees, employee councils or other representative structures can enable the collective employee voice to be heard, whilst a board of trustee directors controls the majority shareholding for the benefit of all employees. There is potential for a bespoke succession solution to be developed for every business.
In addition to enabling employees to have a voice as part of the transition to employee ownership, business owners often wish to provide financial incentives for employees too. If over 50% of the shares in a company are held by an EOT on behalf of the employees, employees can receive an income tax free bonus of up to £3,600 each year. The company can also use performance related bonus schemes as normal to reward individual employees hard work.
The contribution of key individuals tasked with driving the business forward once the current owners step away may also be recognised by granting those employees the option to purchase shares in the company in the future. Buying shares means having ‘skin in the game’ and this can be an added incentive for senior employees to ensure the business remains successful, profitable and maintains or increases its value. As direct shareholders in the company, these employees will be entitled to receive dividends on their shares and can realise any increase in value in the company that they helped to create when they sell their shares.
At the point of the sale of shares to the EOT, the business will generally take on a debt for the remainder of the value of the shares that it still owes to the exiting owners, to be paid out of the future profits of the business. Whilst this does not necessarily need to be reflected on the balance sheet of the business, it does mean that there is a window where shares can be offered at significantly discounted rates to any key employees. For employees offered shares or share options at this point, it means that the value of their shares will appreciate purely by virtue of the debt in the business being paid off. This creates a potentially powerful incentivising tool.
However, any direct share ownership scheme needs careful consideration around its design and objectives. In particular:
Any share scheme should seek to align with all of the above
The two main share schemes used by UK SME employee owned businesses are Enterprise Management Incentive share options (EMIs) and Share Incentive Plans (SIPs). In this article I will look in detail at the use of EMI share options.
A share option is when a company grants an employee the option to purchase a certain number of shares in the company at a specified price. The employee will usually be able to exercise their option after a specified period of time has elapsed. If, in the period between the option being granted and the employee exercising the option, the value of the company has increased, the employee will be buying the shares at a discount.
At the point when the option is exercised, any option gains, that is the amount by which the value of the shares on the exercise date exceeds the price paid by the employee to exercise the option, are normally subject to income tax, and often National Insurance. However, tax efficient share option schemes such as enterprise management incentives (EMI) can be used to minimise the tax payable by employees and therefore make share options more attractive.
What is an EMI option?
An EMI option is a flexible and tax efficient share option specifically designed to help small and medium sized businesses recruit and retain employees and to support their future growth. EMI options work in the same way as other share options, that is, the company grants an employee an option over a specific number of shares in the company, at a specific price, at some point in the future but statutory reliefs mean employees pay less tax on their gains and there may be tax benefits for the company too.
EMI options can be very flexible as they can be offered to some or all employees and can be granted over different classes of shares. Some businesses use them incentivise a handful of key employees while others use them as part of an all-employee scheme.
What are the tax advantages of an EMI option?
Grant of the option: If an employee is granted an EMI option, there is no tax payable on the grant of the option.
Exercise of the option: There will be no income tax payable on the exercise of the option if the exercise price paid by the employee to buy the shares subject to the option is at least equal to the value of the shares when the option was granted.
Sale of the option shares: When an employee sells the option shares, capital gains tax (CGT) will be payable on the difference between the sale proceeds and the market value of the shares when the option was granted. However, the shares will qualify for Business Asset Disposal Relief (previously known as entrepreneurs’ relief), provided certain conditions are met including continuing to be employed by the company and holding the shares for 24 months (the option period counts towards this 24 month period) for the relief to apply. This usually means that the employee will pay CGT at a special 10% rate.
The company: a corporation tax deduction maybe available when the EMI options are granted (subject to the company and the employee satisfying the relevant criteria).
EMI Qualifying Criteria
As with most tax reliefs, there are a number of other criteria that the employee and the company must meet. In particular:
A recent HMRC review evaluating the impact of EMI schemes concluded that EMI is fulfilling its core objectives of helping recruitment and retention of employees in small and medium sized businesses and supporting their future growth.
Incentivising key individuals using EMI options is one just element that can be considered when tailoring an employee ownership structure that reflects the needs of a business, its owners and its employees.