Many start-up companies may have important members of staff who could benefit from being given incentives to commit themselves to the company. The UK has provided a way to do this through enterprise management incentives, which are a type of company share scheme that permits incentives to be given to key employees who are valuable to the company. Participating employees must spend at least 25 hours per week (or 75% of their working time if less) working for the company.
A company with gross assets of GBP 30 million or less and fewer than 250 full time employees or the equivalent carrying on a qualifying trade in the UK can grant options over ordinary shares if they are fully paid up and not redeemable or convertible. Qualifying activities do not include dealing in land, financial trading, and leasing or property development. The grant of options is limited to a total value of shares at the grant date of not more than GBP 3 million. There is a limit of GBP 250,000 on the value of shares over which an option may be held by one employee.
No income tax or national insurance contributions are charged on the grant of shares or when the option is exercised by the employee, except where the exercise price of the option is discounted to below the value of the shares when the option is granted. When the shares are subsequently sold by the employee capital gains tax is due, but the entrepreneur’s relief may be available, reducing the tax to an effective rate of 10% on the first GBP 10 million of lifetime capital gains of each individual.
The directors and shareholders of small companies are often reluctant to grant such incentives to their key employees because they fear they are giving away some of the value they have built up in the company and they are also afraid of giving away their control over the company. These fears are unfounded provided that the scheme is set up in the right way and that proper professional advice is taken on setting up the scheme.
The employers being granted options to buy the company shares would generally buy their rights at the current share price, so on granting the options the company is not giving away any value. The reason for giving the options is that the employees will then have a share in the future growth in value of the company’s shares, and this will give them an incentive to stay with the company and work to increase its value.
The problem of giving away control of the company can be resolved by setting up a class of non-voting shares that do not give holders the right to vote on issues concerning the company. The options could be granted only on these shares so that the employees if they exercise the options will still not be able to vote at meetings. The control of the existing shareholders over the management of the company will therefore not be affected.
It is also worth pointing out that the conditions for the enterprise management incentives are flexible enough to permit the directors to lay down rules as to which employees are eligible to purchase options. The grant or exercise of the options can be related to performance criteria if necessary. A new class of shares could be created for the purpose and restrictions placed on voting rights, dividend rights or other matters. There could be rules as to when the shares would be forfeited, for example related to the circumstances in which the employee leaves the company. There is flexibility on the type of performance criteria that could be included as a condition of exercising the options and how these are measured.
Generally the rules of the scheme could be drawn up on the basis of a template that can be adapted to the company’s needs. The articles of association of the company may need to be amended to accommodate the requirements of the scheme and the amended articles need to be filed with Companies House. Formal offer letters and option agreements could be drawn up following which the directors can agree on which employees are to be offered options.
The option must be in writing and refer to the relevant legislation. It should mention that the options can be exercised within ten years and that the rights cannot be transferred. Details on performance criteria, the exercise price, the number of shares over which the option can be exercised and conditions of forfeiture should be put in writing. HMRC should be notified of the grant of the option using the relevant form, and an annual return of the EMI scheme must be submitted. Companies considering offering enterprise management incentives should take appropriate professional advice.