An Introduction to Share Options for Startups & SMEs

The market for talent is fast moving within UK startups and SMEs, and therefore attracting and retaining top talent is a critical challenge. Share options have emerged as a useful tool for businesses to align the interests of their employees with the long-term success of the company. Among these, the Enterprise Management Incentive (EMI) scheme and unapproved share options are particularly prevalent. This article explores these share option schemes, their benefits, eligibility criteria, and how digital platforms like SeedLegals and CapDesk, along with specialist consultants like The Mill Consultancy, can streamline the process and ensure compliance. According to Vestd, another digital platform, 16,300 UK companies operate tax-advantaged EMI schemes with 45,000 individuals being granted EMI options every single year in the UK.

The Benefits of Implementing Share Options

Share options serve as a powerful incentive, aligning employees' efforts with the company's performance. For startups and SMEs, this alignment is crucial for sustained growth and innovation. Key benefits include:

• Attracting talent — competitive share option packages can help attract high-calibre talent.
• Retaining employees — share options encourage long-term commitment from team members.
• Tax efficiency — particularly with EMI schemes, both employers and employees can enjoy significant tax benefits.

Enterprise Management Incentive (EMI) Scheme

Designed for small to medium-sized enterprises, the EMI scheme offers a tax-advantaged way to grant share options to employees. It's highly flexible and tax-efficient, allowing employees to benefit from the growth of the business with the potential for reduced tax liabilities when they exercise their options. The main features of the scheme include:

• No income tax or national insurance contributions arise on the grant of options or the exercise of options (as long as they’re at market value)
• Capital Gains Tax at 20% will be payable on the sale; but this falls to 10% on the first £1m after two years thanks for Business Asset Disposal Relief
• The market value of shares can be agreed with HMRC in advance
• Companies can also apply for advanced assurance that their scheme qualifies for EMI rules

Eligibility rules and limits include:

• A company or group must have fewer than 250 full-time equivalent employees
• All employees must work at least 25 hours a week or 75% of their total working time for the company
• Up to £250,000 worth of shares can be granted to each individual
• The limit on the total value of options that can be granted under EMI is £3m

Unapproved Share Options

Unlike EMI schemes, unapproved share options do not have the same tax advantages, but offer greater flexibility in terms of eligibility and limits. They can be granted to any employee, director, or third party (e.g. advisors) without the constraints of the EMI scheme, making them a versatile option for many businesses.

While share option schemes offer considerable benefits to startups and SMEs, administering these programs can present significant challenges. Understanding these difficulties, recognising common pitfalls, and employing strategic tips can help ensure smooth operation, particularly in scenarios involving company exits or HM Revenue and Customs (HMRC) reviews.

Challenges of Administering Share Option Schemes

• Complexity of regulations — both EMI and unapproved share option schemes are subject to intricate tax laws and regulations. Ensuring compliance requires a thorough understanding of these rules, which can be daunting, especially for early-stage companies without dedicated legal or financial teams.
• Documentation and record-keeping — maintaining detailed records of grants, exercises, and valuations is crucial. Poor record-keeping can lead to administrative headaches and difficulties during HMRC audits or company exits.
• Valuation disputes — determining the fair market value of share options is critical but can be contentious, particularly for unquoted companies. Disagreements over valuations with HMRC or among shareholders can complicate exercises and tax liabilities.

Common Pitfalls

• Failing to obtain HMRC approval — for EMI schemes, failing to secure or maintain HMRC approval can result in the loss of tax advantages for both the company and its employees, transforming a tax-efficient scheme into a tax burden.
• Overlooking dilution effects — not properly planning for the dilutive effect of option pools can lead to dissatisfaction among existing shareholders and option holders, particularly if dilution impacts the perceived value of their shares or options.
• Miscommunication — a lack of clear communication regarding the terms, conditions, and potential outcomes of share options can lead to misunderstandings and discontent among employees, especially if their expectations are not met at exit.

Tips to Avoid Challenges

• Seek expert advice early — engaging with platforms like SeedLegals, CapDesk, or consulting specialists like The Mill Consultancy early in the process can help navigate the complexities of share option schemes, ensuring compliance and strategic alignment with business goals.
• Implement robust administration tools — utilise digital administration tools to keep accurate records, track option pools, and manage valuations. These systems can streamline the process, reduce errors, and facilitate reporting and compliance.
• Regularly review and update schemes — periodically reviewing your share option scheme against current regulations, company valuation, and business objectives allows for timely adjustments in response to changes, minimising risks and maximising benefits.
• Prepare for exits and HMRC reviews — develop a clear strategy for handling share options upon exit, including scenarios such as trade sales, IPOs, or buyouts. Additionally, prepare comprehensive documentation to support valuations and decisions made throughout the life of the scheme to mitigate issues during HMRC reviews.

With the right support and tools, companies can navigate the complexities of share option administration, ensuring that their schemes are robust, compliant, and aligned with their strategic objectives.

Given the complexity of the regulations, it’s always worth using a third party to support you with implementing a share option scheme.

Digital Tools for Share Option Management

• SeedLegals specialises in automating the legal setup of EMI schemes, guiding companies through the HMRC approval process, and managing option pools.
• CapDesk offers a broader set of features for cap table management, including EMI and unapproved share options, providing startups with a clear view of their equity distribution and making complex option administration manageable.

Specialist Consultancy Support

We’ve used and can highly recommend The Mill Consultancy as expertise available to UK startups and SMEs seeking personalised advice on implementing share options. Specialist consultants can offer tailored guidance on:

• Scheme design, to craft a share option scheme that aligns with your business goals and culture.
• Compliance and strategy, ensuring your scheme complies with tax laws and regulations while optimising tax benefits.
• Implementation and communication, helping you implement the scheme effectively and communicate its benefits to your team.

Conclusion: Empowering Growth with Share Options

For UK startups and SMEs, share options represent not just a method to reward and motivate employees, but a strategic tool to drive business growth. Whether through the tax-advantaged EMI scheme or the versatile unapproved options, share options can significantly contribute to a company's ability to attract and retain key talent. Administering share option schemes requires careful planning, diligent management, and clear communication, and therefore it’s crucial to understand the challenges and pitfalls associated with these schemes. Utilising digital tools and specialist consultancy services ensures that your share option schemes are not only compliant but also aligned with your business objectives and culture. As you explore the potential of share options, consider the blend of technology (for ease of administration) and expertise (for bespoke advice) that best supports your desired incentivisation plans.