Share options can be an excellent way for start-ups and small businesses to attract, incentivise and gain loyalty from key employees. In the early days of any business, the loss of a key member of the team can be devastating and can even lead to business failure. While giving away equity in the business isn’t something you want to do lightly, this kind of incentive can align your goals with directors and other essential members of staff and help to keep them in place.
What are share options?
A share option is the right to buy a certain number of shares, at a fixed price, sometime in the future. If an employee is offered a share option, it’s likely to mean the company is interested in retaining the services of that individual by giving the employee the opportunity to profit as the company grows.
An employee can exercise their options, i.e. by the shares, once they have satisfied preset performance criteria or after a predetermined period of time. Alternatively, share options may only be granted or exercised when the company has reached certain targets.
Why are share options granted?
Clearly, giving away equity in a company is something that needs to be carefully considered. Many business owners understandably prefer to keep hold of as much of their business as they can, preferring to pay commission-based bonuses or cash bonuses instead. However, for key members of the team, share options can be a very effective way to:
- Attract, retain and motivate key employees;
- Incentivise employee to meet performance measures or time limits;
- Improve reported results by granting share options rather than increasing salary;
- Increasing competitiveness by offering an attractive and diverse remuneration package.
What share option schemes are available?
Broadly speaking, there are three share option schemes that can be used by SMEs. That includes:
- Enterprise Management Incentives (EMI)
- Save As You Earn (SAYE)
- Company Share Option Plan (CSOP)
Enterprise Management Incentives (EMI)
This type of share option, which we have covered previously here, is the most popular type of scheme available. It is approved by HMRC and allows shares to be granted to certain employees without any tax implications. In this scheme, a market value of the shares is agreed when they are granted and this is the amount the employee will pay when exercising (buying) the shares. No income tax bill will arise from the purchase of the shares if their value when exercised is more than when it was granted.
It is not unusual for the company to place certain performance conditions on the employee or the business before the options can be exercised as a way of justifying the reward. The benefits of this scheme are that:
- Share options worth up to £250,000 can be granted without any tax or NICs payable by the employee;
- The company will receive corporation tax relief on the costs of running the scheme;
- The employee can exercise the shares at significantly more than they were granted for;
- The company can choose which employees qualify for the scheme.
Save As You Earn (SAYE)
Save As You Earn is a monthly saving scheme that gives employees a tax-free bonus and an option to buy shares at the end of the scheme. The share price is set at a discount of up to 20 percent at the start of the savings contract, so if the company has done well, employees can profit considerably.
SAYE schemes typically last three or five years, with employees saving up to £500 a month. This scheme must be made available to all employees who have been with the company for a certain amount of time. The benefits include:
- The interest and any bonus at the end of the scheme are tax-free;
- No income tax or National Insurance is paid on the difference between what employees pay for the shares and what they’re worth;
- Businesses benefit from the loyalty of their staff over the term of the savings contract.
Company Share Option Plan (CSOP)
A Company Share Option Plan allows a company to grant share options to selected directors and employees over shares with a maximum value of £30,000 per employee at the date of the grant. There is no tax or National Insurance payable on the gain made when the option is exercised as long as the share option has been held for at least three years. The benefits are:
- The company can choose which employees are included in the scheme;
- No income tax or National Insurance is payable on any gain;
- Can be an option for companies unable to grant the more tax efficient Enterprise Management Incentives because they are not a ‘qualifying trade’ under EMI terms.
Implementing a share option scheme
To implement share options there is certain documentation a business needs to put in place. That includes:
- Board and shareholder resolutions – To approve the scheme and the granting of share options;
- Share option plan rules – Documenting the general rules that will apply to all share options granted;
- Individual option award agreements – Detailing each individual’s share options and any performance criteria they must meet.
Before the option can be granted, you will also need to check any shareholder agreements already in place to make sure no other consents or approvals are required.
If you plan to put EMI share options in place then there are a few more considerations to take into account to keep you on the right side of HMRC:
- You will need an accountant to help you agree the valuation of your company with HMRC;
- EMI share options must be granted within 60 days of the valuation with HMRC or the valuation will have to be redone;
- HMRC must receive notification that the share option has been granted within 92 days of it being made.
How can we help?
Prosper provides a comprehensive approach to accountancy, tax & business growth services for start-ups across the UK. We are your bookkeeper, accountant and finance director all rolled into one. Check out prosper.accountant to learn more about how we can help your business.