You will probably have key consultants or members of staff whose expertise are paramount to the future success of your business. In most cases these people will be rewarded by way of annual bonuses and/or attractive salaries. That’s fine in terms of getting them to hit their short term targets but it does little to tie them in to your business. An alternative is to look at equity based incentive schemes, which whilst necessarily involving some complexity, do work well in terms of keeping your best people. Here are some basic facts on the most common equity based incentive schemes:
Enterprise Management Incentive (EMI) Scheme
- You grant employees the options to acquire an equity stake at a set exercise price at some point in the future (normally when the company is being bought by a third party).
- The exercise price is geared towards the value of the company at the time the options are granted, so if the company’s value goes up the employee stands to gain. The cherry on top is that the value uplift will (as things stand) be taxed under the friendly CGT rules (more below).
- If the exercise price is below the market value as at the date the options are granted then the employee will be looking at paying income tax (and possibly NI) on the difference.
- The options can be linked to certain key performance targets and you can be selective about which employees you involve.
- EMI allows for options worth up to £250,000 per employee
- There are also qualifying criteria in respect of the employees working week and commitments, most of which I do not anticipate being an issue.
- No tax is ever payable under this scheme until options are exercised.
- There are some costs involved in setting up and administering the scheme but EMIs remain the popular choice in the SME world.
There are some attractive tax breaks to the employee as the gain made on the exercising of the option should be subject to capital gains tax at a rate of 10% (assuming Entrepreneurs’ relief is available). Here’s a brief example:
- Let’s say the value per share is £0.40 at the date the option is given (today) and £1 at the date of exercise (i.e. just preceding a sale).
- If, on exercise, the employee buys the shares at £0.40 then there is no income tax or NI charge.
- If they buy them for (say) £0.01 then there is income tax and NI (because they’re what’s called a readily convertible asset) to pay on the difference between £0.01 and £0.40.
- The employee will then go on to sell the shares, and the uplift from £0.40 to £1 is taxed as a capital gain, and entrepreneurs’ relief usually applies to give a 10% tax rate on that gain.
- Let’s assume that the exercise price was £0.40, this means the employee is looking at paying £0.40 for a share and then £0.06 to cover the tax meaning that they effectively get to keep £0.54 in the £.
Company Share Option Plan (CSOP)
This scheme can be used to give options to employees to buy shares in their employing company. Typically the options must not be exercised within 3 years of grant in order to qualify as CSOP options, and in order for their to be no PAYE charge the exercise price must be no less than the market value at the date of grant.
- Using the figures above, you might grant options now that allow the employee to buy shares at £0.40 (today’s value) in 3 years time (when the shares are worth, say, £1).
- The EMI entrepreneurs’ relief concessions do not apply to CSOP schemes, so to qualify for ER the employee would have to exercise, then for at least 12 months (and at the date of sale) hold at least 5% of the share capital and be an officer or employee.
The cumulative value of options granted to an employee must not exceed £30,000 at the date of grant.
Say as You Earn (SAYE)
Employee enters into a 3 or 5 year contract to save between £5 and £250 per month in the scheme. At the end of the savings period the money is used to buy shares at a fixed price, which may be set at up to a 20% discount. These are not popular schemes for small companies, they are more popular in larger businesses.
Employee Shareholder Scheme
In essence the employee gives up certain employment rights in return for tax advantages on acquiring shares in the employing company. The shares given to the employee must be worth at least £2,000 (no upper limit) BUT only the first £2,000 of value will qualify for an exemption from a PAYE charge.
On a subsequent disposal, up to the first £50,000 of employee shareholder shares acquired are exempt from capital gains tax up to a limit (in terms of gain) of £100,000.
Share Incentive Plan (SIP)
SIPs are a very tax efficient way of giving small numbers (low values) of shares to employees as a long term incentive. But they are required to be ‘all employee’ schemes (all on the same terms) so there would be no way of using the scheme to distinguish your target employee from the other employees of the firm.
Beyond these solutions you may consider Growth Shares or even a Phantom Share Scheme.
The next step
Whatever your preference, tying in key staff maybe fundamental to the future of your business and you shouldn’t risk deferring this for another day. Please call call us on 0845 606 9632 or email us at firstname.lastname@example.org.