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EMI option schemes – Getting the terms right from the outset

Cormac Marum offers some advice on the popular share incentives scheme

Providing options under EMI schemes are clearly the most popular form of share incentives available to small and medium-sized UK companies.

They can be set up for key select employees who really can make a difference to the future success of a company rather than have to be introduced as an all-employee scheme across the board to everyone.
EMI schemes can also be set up quickly and easily without a plethora of paperwork and procedures.

Many EMI schemes set-up are ‘exit-only’ schemes in that the options can be exercised only when a sale of the company takes place. The option-holders can then partake in the share sale alongside the original shareholders as a reward for them helping the original shareholders to build-up the company to a successful outcome.

Despite the ease in setting them up, it is important that, at the outset, sufficient thought is given to getting the appropriate terms in place to suit the particular company in question.

This is because HMRC is increasingly policing the EMI rules more stringently.

Ever since EMI option schemes were introduced, there has been a requirement to have the scheme rules written down, although HMRC has not gone through them line-by-line when initially such EMI schemes have been registered.

Subsequent changes to those rules have therefore always run the risk that they have constituted the cancellation of the old option and the grant of a fresh EMI option.

Why does a cancellation of an old option and the grant of a fresh EMI option matter?

1. The option price is always set in relation to the open market value of the shares at the date of grant of the option. Normally, that open market value will be lower earlier in the history of company’s business. So if an option is treated as a cancellation and a grant of a fresh EMI option, the open market value of the underlying shares on fresh grant may be higher than the exercise price set under the old option. If the exercise price is unaltered, there could be unexpected and unwelcome PAYE and NIC charges arising on exercise on exit.

2. To obtain the benefit of any Business Asset Disposal (‘BAD’) relief, there must be two full years between grant of the EMI option and sale of the resulting shares. The anticipated 10% CGT on disposal may therefore be squandered for the key employees if there is a cancellation and fresh grant of EMI options in the two years prior to exit.

It is therefore always sensible, when introducing an EMI scheme, to take appropriate professional advice before getting under way.

We at Harwood Hutton have assisted many clients with the successful introduction of EMI schemes which have sought to incorporate appropriate terms to cover likely scenarios which might arise between introduction and eventual exercise.

If those likely scenarios are covered off in the original rules, that mitigates against later surprises causing disappointment from any subsequent cancellation and fresh issue.

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