UK: What are the different types of employee share schemes in the UK?

As a startup, paying a premium for team members can be challenging if you have yet to raise plenty of capital. One solution is an employee share scheme. Using a share scheme allows you to offer your employees equity in your company. Most high-growth startups will operate an employee share scheme, as offering team members equity in the company can help bridge the gap between a startup salary and an equivalent corporate salary. Employee share schemes are also a great way to ensure your employees feel like they have a real ownership stake in the business and that their interests align with those of the business. The startup's success will be their success.

Most employee share schemes in the UK operate by giving employees the option to acquire shares in the future rather than issuing shares directly. There are several different schemes, some of which have tax advantages. This article explores the main types of share schemes.

Enterprise Management Incentive (EMI) Schemes

The most commonly used share scheme in the UK is the Enterprise Management Incentive (EMI) scheme.

There are several criteria that the company must meet to qualify for the EMI scheme. If you have already established overseas and are looking to set up in the UK, you will need to satisfy the following:

• UK permanent establishment – This is typically a UK company, which could be a subsidiary of an overseas company. Occasionally, an overseas company will set up a 'permanent establishment' ( like a branch) in the UK to meet this criteria.
• Independence test – The holding company issuing the options must not be majority-owned by another company, taking into account the shareholding of any individuals associated with the corporate shareholder. This is particularly relevant where the company issuing the options is located in a jurisdiction where trusts are used, as often the founder's shares may be held by a corporate trustee, which would fall foul of this rule if the founder has a majority shareholding.
• Group-wide limits – You have fewer than 250 full-time employees and gross assets of less than £30 million.

In addition, the individual must satisfy tests before receiving EMI options. In particular they:

• must be a genuine employee;
• have devoted a certain number of hours to the business; and
• own (or would own after exercising their options) 30% or less of the company's shares.

HMRC Approval

If your employee satisfies the above, they will not pay any income tax when exercising their options. This is provided the exercise price paid by the employee is at least equal to the market value at the date the option was granted. To ensure this is the case, you must obtain a valuation of the EMI shares and get this approved by HMRC. Once you have your valuation approved by HMRC, you have 90 days to issue options to employees using that valuation as the exercise price.

To issue options to your employees, you will need a set of EMI Option Plan Rules setting out how the scheme operates. Likewise, enter into an Option Agreement with the employee. Once you issue an EMI option to an employee, you will need to notify HMRC, as well as complete an annual filing.

Company Share Option Plans (CSOPs)

Companies wanting to issue options under a CSOP must meet similar criteria to EMI schemes. However, the valuation to set the exercise price does not need approval by HMRC. Accordingly, there is less certainty that the employee will not have to pay any income tax when exercising options as the exercise price has not been confirmed to be the same as the market value when granting the options.

In addition, CSOPs have less flexibility regarding when employees can exercise their options. Further, employees must hold onto them for at least three years unless certain exceptions apply (for example, they are a 'good leaver').

Save as You Earn (SAYE) Option Plans

A less common form of employee share scheme is a SAYE option plan. The advantage of using this type of scheme is that the employee still gets favourable income tax treatment but can pay up to a 20% discount to the market value at the time of grant when exercising their options. However, you cannot only select key employees to issue with options. All employees with a certain length of service have the opportunity to participate in the scheme.

SAYE options work by setting up a linked savings account that the employee contributes to from their salary. At the end of the savings period, they can either use the money saved to exercise their option and buy shares or withdraw their savings.

Share Incentive Plans (SIPs)

Sips are the only incentive scheme where employees receive shares rather than options. Your startup must offer the scheme to (nearly) all employees and allow:

• employees to buy a certain amount of shares; and
• the company to gift a certain amount of shares each tax year.

Non-Tax Advantaged Share Schemes

If your company does not qualify for any of the above schemes, you are free to issue either options or shares to your employees. However, there may be income tax consequences in doing so.

Importantly, there are many hoops a startup needs to jump through to qualify for a tax-advantaged employee incentive scheme. It is best practice to seek professional advice on which schemes your startup will qualify for and how to implement the most suitable one.

Key Takeaways

Motivating and compensating your employees can be challenging as a startup business when you have yet to raise sufficient capital. Employee share schemes are an effective way to offer your employees equity in your company and bridge the gap between a startup salary and an equivalent corporate salary. This is especially the case when you are bringing your startup to the UK and want to motivate existing employees to make the overseas expansion with you.

There are several types of employee share schemes available, including:

• Enterprise Management Incentive schemes;
• Company Share Option Plan;
• Save as You Earn Option Plans;
• Share Incentive Plans; and
• Non-Tax Advantaged Share Schemes.