Recruiting, retaining and motivating high-calibre people is critical to your business success. But what’s the best way of doing it?
Should you just pay more? Should you pay bonuses? If so, what should these be based on?
The debate of whether to increase salaries and provide bonuses or to share equity is an important discussion within any business. As sensible businesses try to control costs, increasing salaries can be viewed as a risk and many take the view that they want to reward good performance, not just length of service. Share incentive schemes provide a share in the business for your people in return for performance and commitment.
Various share schemes are available. One that works well for small private limited companies is the Enterprise Management Incentive, which is a discretionary share option arrangement commonly referred to as the EMI option scheme.
The policy goal of the EMI legislation was to help companies retain and recruit high-calibre individuals. The rules are relatively simple:
- the gross assets of the company must not exceed £30 million at the time of the grant
- the company should be independent of other companies – it should not be a 51% subsidiary of other companies
- any subsidiaries the company owns must be held by at least 51%
- the company must undertake a qualifying trade (this no longer has to be in the UK, although the company must have a permanent UK establishment)
- the company must have fewer than 250 full-time employees.
HMRC approval is not required, but it must be notified.
Often the argument against providing options is the dilution of the main ordinary class of shares. However, it is possible under the EMI rules to set up a separate class of ordinary share capital to be acquired. The shares need only have voting rights and the right to participate in the distribution of income and capital. EMIs are available to all employees who work for a qualifying number of hours per week and are not associated to a 30% or more shareholder.
Once it is established that you are able to issue EMI options, you can provide that the shares can be exercised no further than ten years after the grant. Criteria for when the option is exercised may be time, performance or a trigger event, such as the sale of the company to a third party. The option agreement should set out to the individual why they are being motivated and what ability they have to exercise those shares. The value of the shares in a company must not exceed £3 million and the maximum entitlement of the value of qualifying options for an individual is £250,000.
In the normal course of business, issuing shares to employees comes with the risk of being viewed as a PAYE benefit (for both employees and employers). However, granting shares under an EMI option provides that no National Insurance contributions are due on the qualifying shares, making it an affordable option compared with other schemes.
In terms of dealing with the gain between exercise price and sale price there has been a positive move from the Government, which has stated that it wants Entrepreneurs’ Relief to be applied to gains on any qualifying shares acquired. The Government has stated a proposal to provide for this within the Finance Bill 2013 and it is viewed that the new rule will apply to EMI shares acquired on or after 6th April 2012.
As the exercise price of EMI options can be set at below market value (although this will have capital gains issues), it can form the basis of a performance share plan without an expensive ‘buy-in’ price.
If an EMI option scheme is of interest to you and your business, or if you would like to discuss share incentive plans in general, please contact me: Yavan.firstname.lastname@example.org or 0118 9774045.