The role of EMI options and restricted shares in EOT-owned businesses
EOTs provide a collective benefit to employees, but they often need to be supported with direct ownership for key individuals to ensure that they are rewarded for exceptional performance.
Retaining key individuals can be particularly important where the structure of the EOT includes deferred consideration which needs to be funded using future profits of the business.
EMI options and restricted shares can address an incentive gap by offering key employees:
- Direct ownership stakes: Aligning individual interests with business success, as such incentives will usually be linked to the performance of the company and repayment of any EOT debt
- Financial rewards: Providing the potential for significant financial gains over and above the benefits of the EOT
- Retention incentives: Encouraging long-term commitment to the company, as leaving will usually lead to a loss of rewards.
Understanding EMI options
Enterprise Management Incentive (EMI) options are a tax-advantaged share option scheme available to qualifying UK businesses. They allow key employees to purchase shares at a predetermined price, which may be lower than on an eventual exit because of an increase in overall business values, reduction of any EOT debt, as well as any restrictions on the shares having been effectively released.
Key Benefits of EMI Options
- Tax efficiency: Gains are taxed as capital gains rather than income, often attracting lower tax rates
- Flexibility: Options can be tailored to vest based on performance, time-based criteria and/or repayment of EOT debt
- Employee motivation: Align employees’ interests with company growth and success.
Understanding restricted shares
Restricted shares involve granting shares to employees with certain conditions or restrictions, such as forfeiture if the employee leaves the company before a specified date or milestone.
Key benefits of restricted shares
- Tax efficiency: Gains are usually taxed as capital gains rather than income, often attracting lower rates
- Immediate ownership: Employees become shareholders upon grant, rather than an option, which can provide added ‘skin in the game’. This might also make them eligible to be paid dividends
- Customisable conditions: Restrictions can be tied to performance, tenure, or other criteria.
Challenges and requirements in EOT-owned businesses
When implementing EMI options or restricted shares in an EOT-owned business, there are specific considerations to ensure compliance with legal, tax, and structural requirements, and importantly to ensure that the tax benefits of the EOT are not forfeited.
Preserving the majority ownership of the EOT
Under UK law, an EOT must hold a controlling interest (at least 51%) in the business. Any issuance of shares or options must not dilute the EOT’s majority stake below this threshold.
Employee status
Certain thresholds of share ownership will disqualify employees from receiving proceeds of a sale by the EOT of its shares in the company, and therefore it is important to ensure that these restrictions are fully understood, and the arrangement structured accordingly.
Qualifying for EMI options
To qualify for EMI options, both the company and the participating employees must meet specific criteria. It is important that the criteria for qualifying EMI options are considered and met, as otherwise the arrangement may fall within the status of an unapproved option which has very different tax consequences.
Aligning incentives with EOT goals
Incentive schemes should align with the broader objectives of the EOT, such as promoting employee engagement and long-term business success.
Careful communication is essential to ensure employees understand the value of their awards in the context of the EOT structure, and that those who do not receive such direct awards do not become disgruntled.
Valuable tools for incentivising staff
EMI options and restricted shares provide valuable tools for incentivising key staff within an EOT-owned business. While implementing these schemes requires careful consideration of ownership, tax, and regulatory factors, they can significantly enhance employee motivation and retention.
Where the EOT has been structured to include an element of deferred consideration, such incentives can ensure that key employees are retained and this will provide more security to the sellers.