What is an EMI Option Agreement?

Published:

Feb 13, 2024

An Enterprise Management Incentive (EMI) share option scheme is a tax favourable employee share option scheme that enables shares purchased via an EMI option to qualify for Entrepreneurs Relief. In this guide to EMIs, you will learn all you need to know about them.

Top Features of an Enterprise Management Incentive

Some of the top features of an EMI include, for instance:

✅ EMI schemes provide you with a strong incentive for key employees to stay with the company - as they stand to gain financially from the company's success.

✅ By granting share options, employees' interests are aligned with those of the shareholders - encouraging a focus on long-term value creation.

✅ Employees often benefit from favourable tax benefits on the shares they acquire, particularly regarding reduced Income Tax and Capital Gains Tax liabilities.

✅ EMI schemes can make a company more attractive to potential high-calibre employees, especially when there is a marketplace shortage - offering them a stake in the company's future success.

✅ Unlike cash bonuses, EMI schemes do not require immediate cash outlay, making them a cost-effective way for the business to reward and motivate staff.

✅ Employers do not have to pay National Insurance Contributions (NICs) on the grant or the exercise of the EMI options. This, in turn, reduces the overall cost compared to other forms of employee compensation.

Table of Contents

  • What is an EMI Option Agreement?

  • Employee Options to Buy Shares

  • EMI Rules to be included

  • Clear Benefits Explained

  • When Should You Use an EMI Option Agreement?

  • Why Should You Use an EMI Option Agreement?

  • EMI Requirements

  • What are the Criteria for Employees to Participate in an EMI Scheme?

  • How Does an EMI Scheme Benefit Employers?

  • How is the Exercise Price for EMI Options Determined?

  • Are There Any Limits on the Value of Options Under an EMI Scheme?

  • What Happens if an Employee Leaves the Company Before the Option Expires?

  • What is a 'Disqualifying Event' in an EMI Scheme?

  • How Does an Employee Exercise Their EMI Options?

  • What Are The Tax Implications When an Employee Exercises EMI Options?

  • Does the Company Need to Report EMI Schemes to HMRC?

  • What are the Reporting Requirements for an EMI Scheme?

  • How Can They Help to Attract and Retain Talent?

  • What are the Common Pitfalls of an EMI Option Agreement Explained?

  • What Statutory Requirements Apply

  • Can Part-time Employees Participate in an EMI Scheme?

  • What Happens to EMI Options if the Company is Acquired?

  • Are There Any Restrictions on the Type of Shares That Can Be Offered Under an EMI Scheme?

  • Can EMI Options be Transferred or Sold?

  • Legal Enterprise Management Incentive (EMI) Templates

  • Ready to Get Started with EMI Options?

What is an EMI option?

An Enterprise Management Incentive (EMI) share option scheme is a tax favourable employee share option scheme that enables shares purchased via an EMI option to qualify for Entrepreneurs Relief.

The scheme is specifically targeted at start-ups and small and mid-sized businesses primarily to help them recruit and retain staff over the long term.

Employee Options to Buy Shares

The option gives the employee the right (but not the obligation) to buy a certain number of shares for a particular price at a later date.

Typically, the option will be subject to a vesting schedule - which means that the employee will receive the options over a number of years.

EMI Rules to be included

The option agreement can either include all of the rules that apply to the option or refer to a separate document - known as the scheme rules. This separate document will consist of all the rules that this option is governed by.

As a result, it is more common for companies to create a general set of scheme rules that apply to all the EMI options granted by the company rather than including the rules in each employee’s option agreement.

Clear Benefits Explained

This has two clear benefits. 

First is transparency - all employees know that they are being issued options subject to the same rules. 

The second is administrative - should the company need to make administrative updates to the rules, this can be done by updating the general rules rather than having to agree on the update with each employee individually.

When Should You Use an EMI Option Agreement?

In order to qualify for the tax benefits of an EMI scheme, the details of the scheme must be set out in writing and agreed to by way of a written agreement between the company and the employee. 

It is, therefore, necessary to use some form of option agreement - either a long-form agreement or an agreement that sets out the number of individual options granted to the employee but refers to the general scheme rules - each time the company grants options to the employee.

Why Should You Use an EMI Option Agreement?

The main reason is that EMI schemes are one of the most tax-efficient forms of share schemes that a company can put in place.

Followed by the ability to keep highly skilled employees engaged with the company over the time term.

EMI Requirements

However, there are a number of requirements that a company must satisfy to be able to issue EMI options. 

In particular, the company must have:

✅ Gross assets of £30 million or less

✅ 250 or less employees

✅ A permanent establishment in the UK

✅ The company cannot be a subsidiary company - i.e. 50% or more of the company’s shares cannot be owned or controlled by another company

Scope of the Company for EMIs

Furthermore, the scope of the company’s business cannot mainly be any of the following:

✅ Banking

✅ Farming

✅ Property development

✅ Provision of legal services

✅ Shipbuilding

✅ The value of all stock options issued by the company may not exceed £3 million of unexercised options at the time of grant

✅ £250,000 per employee / director.

What are the Criteria for Employees to Participate in an EMI Scheme?

Further, the employee receiving the options must work at least 25 hours - or devote at least 75% of their total weekly working time to the company - and cannot own more than 30% of the company’s shares.

How Does an EMI Scheme Benefit Employers?

Employers can use EMI schemes to attract and retain talented staff, align employee interests with shareholders, and benefit from no NICs on granting or exercising options as just being a couple of benefits.

How is the Exercise Price for EMI Options Determined?

When it comes to the exercise price of an EMI, this is typically set based on a valuation agreed with HMRC, aiming to reflect the market value of the shares at the time the options are granted.

Are There Any Limits on the Value of Options Under an EMI Scheme?

Yes, an employee cannot hold unexercised EMI options with a market value of more than £250,000 - based on the value at the time of grant.

What Happens if an Employee Leaves the Company Before the Option Expires?

This entirely depends on the terms of the scheme. 

Often, options may lapse if an employee leaves, but provisions allow for exercising some of the options in certain circumstances or intervals.

What is a 'Disqualifying Event' in an EMI Scheme?

A disqualifying event in regard to an EMI is an occurrence that results in the loss of the scheme's tax advantages - such as changes in employment status or the company's activities.

Some examples of disqualifying events for EMIs, for instance, can include:

1. Ceasing to Meet Eligibility Requirements

If the company, for instance, no longer meets the EMI eligibility criteria - such as exceeding the £30 million gross assets limit or engaging in excluded activities.

2. Change in Employment Status

If an employee holding EMI options ceases to be eligible, for example, by reducing their working hours below the minimum requirement or just leaving the company.

3. Alteration of Share Capital

An Alteration of Share Capital condition is where significant changes to the company’s share capital affect the rights of the EMI shares - potentially altering their value or even the employee's interest in them.

4. Sale of the Company

If the company is sold and the EMI option holders are not allowed to participate in the sale on the same terms as other shareholders, this can be a reason they become disqualified.

5. Variation of Option Terms

Any variation to the terms of the option agreement that is beneficial to the option holder and not previously approved by HMRC can disqualify them.

6. Failure to Maintain Independence

This occurs if the company becomes a subsidiary of another company, for instance, or if it acquires a controlling interest in another company that is not a qualifying subsidiary.

7. Receipt of Prohibited Assets

If the company starts using its assets for non-business purposes in a way that is substantial in relation to the company's business, this can mean these options become disqualified.

8. Failure to Exercise Options in Time

If options are not exercised within a certain period following a disqualifying event, typically 90 days, the unique tax advantages tend to be lost entirely.

What Happens to an EMI When a Disqualifying Event Occurs?

When a disqualifying event occurs, it's essential for both you, the employer and your employee to understand the implications - particularly regarding tax liabilities on both parties.

The specifics, for instance, can vary depending on the event's nature and the EMI scheme's terms - so professional legal advice is often necessary to navigate these situations.

How Does an Employee Exercise Their EMI Options?

Employees can exercise their options by purchasing the shares at the predetermined exercise price - typically triggered by specific events like a sale of the company.

What Are The Tax Implications When an Employee Exercises EMI Options?

Usually, there's no Income Tax or National Income Contributions (NICs) due at the time of exercise - if the exercise price was at least the market value at the time of grant. 

Capital Gains Tax may apply on the eventual sale of the shares, though.

Does the Company Need to Report EMI Schemes to HMRC?

Yes, companies must notify HMRC of the EMI scheme within 92 days of granting options and submit annual returns detailing the scheme's activity for review.

What are the Reporting Requirements for an EMI Scheme?

Additionally, companies must notify HMRC of the EMI scheme within 92 days of the option grant. 

They further also need to submit an annual return, detailing all EMI option grants, exercises, cancellations, and any other relevant events.

How Can They Help to Attract and Retain Talent?

If the company is able to grant EMI options, it should consider giving options to attract and retain talent. 

Options offer a competitive, cost-effective alternative to the salary provided and align the employee’s long-term interest with that of the company.

The result is a workforce that is motivated and literally invested in growing the company.

What are the Common Pitfalls of an EMI Option Agreement Explained?

The most common pitfall is failing to comply with the statutory requirements necessary for the option to qualify as an EMI option. 

For instance, if these are not met, the favourable tax treatment will not apply - with potentially significant financial consequences for both the company and the employees who received the options.

What Statutory Requirements Apply

These statutory requirements apply both to:

✅ The option agreement

The agreement must include details of the grant date, the number or maximum number of shares under the option, the exercise price (or the method for determining it), and when and how the choice may be exercised.

✅ The processes that must be followed when granting options

For example, the employee must be provided with a signed copy of the agreement within 14 days of the contract's execution. 

Can Part-time Employees Participate in an EMI Scheme?

Yes, part-time employees can participate, provided they work a minimum of 25 hours per week or, if less, 75% of their total working time.

What Happens to EMI Options if the Company is Acquired?

If a company is acquired, EMI options may be:

1) Rolled over into the acquiring company's share option plan

2) Exercised at the time of acquisition

3) May lapse, depending on the scheme terms and the nature of the acquisition.

Are There Any Restrictions on the Type of Shares That Can Be Offered Under an EMI Scheme?

Generally, the shares must be ordinary, non-redeemable shares. They should, for instance, be fully paid up and not carry any particular rights or restrictions that are not also present in the shares of other shareholders.

Can EMI Options be Transferred or Sold?

EMI options are typically non-transferable. This means they cannot be sold, transferred, or given away to another person.

They are only exercisable by the employee to whom they were granted and usually lapse upon the employee's departure from the company.

Disclaimer:
Please note: Pocketlaw is not a substitute for an attorney or law firm. So, should you have any legal questions on the content of this page, please get in touch with a qualified legal professional.

Book a personalised demo
Enterprise ready.

ISO 27001 certified and GDPR compliant. Data encrypted at rest with AES 256 and in transit with TLS 1.2+.

For information on how to unsubscribe, as well as our privacy practices and commitment to protecting your privacy, check out our Privacy Policy.