Will an EMI scheme get in the way of your exit?
It’s all too easy for well-intentioned incentive schemes to create roadblocks.
It’s no surprise that the government might make the Enterprise Management Incentive (EMI) rules more generous.
EMI schemes are a popular and effective way for business owners to attract and retain talent, by giving key employees the chance to benefit from the growth of the company. But when it is time to sell the company, a poorly implemented EMI can backfire, creating major headaches for the transaction process.
EMI 101
The Enterprise Management Incentive scheme is a government-approved share option program for small and medium-sized businesses. It allows companies to incentivise employees, by giving them options to purchase shares in the business at a fixed price in the future, usually after performance criteria are met or the business is sold.
The scheme offers generous tax breaks. Employees do not typically pay income tax or National Insurance when the options are granted or exercised. When the shares are sold, capital gains tax is paid and Business Asset Disposal Relief (as well the employee’s annual capital gains tax exemption) can be applied. These advantages can make EMI options one of the most tax-efficient means for employees to share in the growth and future exit value of a business.
However, it is easy to make mistakes when planning or implementing an EMI, which could undermine the tax benefits or even risk the success of an exit. You can expect every aspect of the EMI to be scrutinised during due diligence. A poorly implemented scheme can undermine buyer confidence and lead to additional indemnities, or even retention of part of the consideration to cover potential liabilities associated with the EMI.
This is a complex area, and we would always suggest that you speak to a specialist equity incentives advisor before proceeding with an EMI.
Here are a few of the big issues to be aware of.
Timing
If you’re already having serious discussions about selling your business, it’s probably too late to consider putting EMI options are place. HMRC can deem the EMI grants to be invalid, if the options are awarded when negotiations for the sale of the company are underway. The basic rule is to make sure the options are in place long before any concrete exit planning takes place.
Compliance and deadlines
The tax benefits of an EMI scheme can be lost if HMRC’s strict reporting requirements are not adhered to. All option grants need to be registered with HMRC by 6th July after the tax year in which they took place.
Companies must also file an annual EMI return setting out all grants, exercises, lapses and leaver events. Failure to submit the information can incur penalties, and could also undermine the entire EMI framework when it is scrutinised at exit.
Valuations
When the company grants options, they are normally exercisable at a fixed price based on the value of the company’s shares at the date of grant. If HMRC later determines that the valuation used at grant was too low, it can pose a risk to the tax benefits of the scheme.
It is possible to ask HMRC to agree the proposed valuation before the options are granted. If HMRC agrees to the valuation, then the company has 90 days to grant options using the confirmed value. Although it is not mandatory to seek HMRC’s approval, doing so helps to give employees certainty about the future tax treatment of their equity incentives.
Leaver provisions and departing employees
The scheme’s documentation must include unambiguous provisions relating to employee departures. The wording should identify the different types of leaver (covering everything from retirement to misconduct) and clearly explain the consequences with regards to the share options.
Discretionary Powers
If the scheme is vaguely drafted, giving the company too much flexibility and discretion in how it chooses to operate the scheme, HMRC can potentially refuse to recognise options as qualifying EMI grants. This can trigger expensive remedial actions, including the cancelation of existing share options and the issuance of new grants that lack EMI tax benefits.
Get an EMI health check
As mentioned above, EMI schemes are complicated and getting them wrong can create real problems.
Whether you are thinking of putting a new scheme in, or starting to think about your exit and wondering if your EMI scheme is all in order, it is a good idea to get a professional review of your equity incentives.
At Rockworth, we’ve worked with a number of specialised EMI advisors, and we are always happy to make an initial introduction, if you have any concerns about this area of your business.
