One of the most common conversations we have with fast and growing businesses (often technology businesses) is about how to attract and retain their best people. A big part of the success of such business is finding and keeping the right people – and I know from conducting many interviews over the years, just how hard it is to find truly good people – and when you do, you need to grab them, hold on to them and not let them go.
Using share options is a way of doing that. If you structure options correctly, you also help to align the individual’s objectives with your own as the business owner. Typically, a business owner is striving for a capital realisation event – i.e. a sale. Reaching that point can be a lot of hard work and to get there you will need the help of others – how do you get that and prevent them from leaving for a competitor?
You might offer them a cash bonus for great work done – but that doesn’t retain them as once the bonus is paid, they are free to go. Involving staff in the equity of the business is a good way of putting some handcuffs on people. However, just giving someone shares in a business might give them an unwanted tax charge that you as the employer have to pick up (giving your highly prized employee a tax liability isn’t a great incentive). The solution needs more thought than that – and the share option is the normal weapon of choice here, particularly the EMI option (an HMRC approved scheme).
To understand why EMI options are attractive, we first need to understand how unapproved options work. Let’s imagine that we have an ‘exit only’ share option scheme (i.e. the options can only be exercised and converted into shares the nanosecond before a sale, which is how the majority, but not all, of share option schemes work). Let’s say the share options are granted with an exercise price of £1, but are exercised two years later when the value per share is £10. Income tax of up to 45% and NIC will be charged on the difference between the price paid (£1) and the market value (£10).
Let’s then consider EMI options. These work differently in that the income tax at the date of exercise is paid on the difference between the price paid (£1) and the market value (£1), with the residue taxed to CGT at entrepreneurs’ relief rates (10%) assuming that the options and shares have together been held in excess of 12 months. The fact that the EMI option holder has less than 5% of the ords and votes is irrelevant. All of this is laid out in the time value axis below (with an interval between exercise and sale to evidence the impact of EMI) where you can see all of the option profit arising above the market value at the date of grant is subject to CGT and not income tax.
In addition, with EMI the company gets a tax deduction on the difference between the price paid for the shares and the market value at the date of exercise (not grant). Many people miss this and valuable relief is lost – on a deal this deduction is usually used by the vendor to increase the sales price or as a significant bargaining chip in the middle of all the typical complex negotiations.
With an increasing competitive jobs market, and truly skilled individuals are exceptionally hard to come by, we are seeing many businesses from many different sectors looking to EMI options to help attract and then retain those key people. EMI options can be used as part of a suite of solutions combined to form an appropriate pay package – such a package will also likely include cold hard cash and a contributory pension, medical cover and so on. The business owner must carefully consider what he wants the EMI options to do – if he is planning to exit in 5 years’ time, then exit only options might well be appropriate, but if that is not the case, then exit only options will not be very attractive to the key person and different thinking might need to be applied, such as the option becoming exercisable when turnover breaches a certain point. Again, there is thinking to do because if the option can be exercised earlier than an exit, the option holder will become a proper shareholder, and suddenly the 100% will have a business partner and someone that he has to consider in the decision making process, perhaps even the need for a formal shareholders’ agreement.
Of course EMI is not the only game in town (others do exist), and there are a number of qualifying criteria that need to be met and reviewed – so as with all things advance planning, thinking and research is important.