Alternatives to EMI, as told by Orrick Partner Ian Shaw

Alternatives to EMI, as told by Orrick Partner Ian Shaw

Author: Scarlett Pierce
Read time:  4 minutes
Published date:  30 September 2020
Updated date:  1 May 2024
Last week's ESS webinar was packed with practical takeaways on employee share schemes. In this blog, we summarise the advice given by Orrick law firm partner Ian Shaw.

Last week's employee share scheme (ESS) webinar was packed with practical takeaways for companies looking to introduce, or improve, their employee share schemes. The event was split into two tracks: “ An introduction to EMI schemes” with Jerry Davison, Managing Director and Founder of accountancy firm The Mill Consultancy, and “Alternatives to EMI” with Ian Shaw, Partner at Orrick, Herrington & Sutcliffe LLP.

This article summarises track two. Our thanks go to Ian Shaw for taking part, and Capdesk Co-Founder Christian Gabriel for hosting.

Outgrowing EMI – the next steps

Track two of the webinar began with Ian explaining that organisations become ineligible for EMI after exceeding the gross assets test of £30 million or employing over 250 people – whichever comes first. 

However, Ian stressed, it’s not always a case of “after EMI.”

“Some companies won’t ever qualify for EMI. Non-qualifying trades include hotel management, financial services, law firms and accountancy firms.”

Such organisations must look to alternative schemes to meet their needs.

Exploring alternatives to EMI

Company Share Option Plans (CSOPs) are a natural place to begin. Though they enjoy a broadly similar tax treatment to EMI, there are significant differences. 

First, CSOPs require employees to hold their options for three years before exercising, unless you meet certain exemptions.

Second, the upper-value limit on CSOPs is set at £30,000 [note that this was increased to £60,000 in April 2023], significantly lower than the maximum legal value of EMI shares (£250,000). 

Warning that you can quickly reach the limit of both CSOP and EMI, Ian advised employees to keep a careful eye on the value of their options. “In some cases, employees may need to exercise some of their EMI shares to prevent their CSOP shares invalidating them.”

Looking beyond EMI and CSOP

Once both EMI and CSOP schemes are exhausted, there are three main options available to businesses: share options, cash-based options and actual shares.

While both EMI and CSOP are a type of share option, companies can also look to non tax-advantaged share options for an alternative. Also known as ‘unapproved options,’ employees must pay regular income tax on all profits.

Cash-based options, also referred to as ‘shadow equity’ or ‘ phantom options,’ cannot be converted into shares. Touching on the reasons why these options are popular, Ian explained that they’re usually offered for one of three reasons.

“Cash-based options are often used in countries where share options are difficult, when you don’t want employees to share in the equity of your company, or when you’ve maxed out your employee option pool.”

The third option is issuing actual shares to employees as restricted stock. Typically, these options suffer from heavy taxation although there are ways around this.

“One way around is to issue stock with restrictions that fall away in five years’ time. That way, you pay heavy tax upfront, but any future gains are only subject to 20% tax, or a business assets relief tax of 10%,” explained Ian.

Share schemes and multi-jurisdiction businesses

Having discussed the main alternatives to EMI, the discussion turned to companies operating across multiple jurisdictions.

Taking the US as an example, Ian highlighted how processes and regulations in distinct jurisdictions can impact on the performance of an employee share scheme.

“If you have a presence in the US, you’ll need a 409a valuation to issue shares. 409a valuations tend to be much higher than those HMRC would approve. As a result, using your 409a valuation to set a share price for all employees across all jurisdictions would mean the scheme is not tax-optimised for those in the UK.”

However, optimising for each jurisdiction will be too complex for most organisations. 

Instead, Ian advises companies to “think about where the bulk of their employees are based, and concentrate their scheme on that jurisdiction. You can always compensate those in other locations with a bonus.”

Liquidity events and non-employee shares

Closing the discussion out, our speaker turned to alternative exit mechanisms and awarding shares to non-employees.

Looking beyond traditional IPOs and sales, Ian suggested that there were two other types of liquidity event that warranted further attention – employee benefit trusts and secondary sales.

“If you have an employee benefit trust set up, employees can sell their shares back to the company via the trust. With a secondary event, unlisted shares are sold by employees – often back to the company. This gives employees liquidity on a cashless basis, as they never have to purchase the shares to receive the tax-proof gain.”

In terms of awarding shares to non-employees, Ian reported that most advisors, consultants and non-executive directors are rewarded with growth shares or JSOP shares.

However, he also articulated the potential risks involved in doing so.

“As an employer, you need to proceed with caution. Making an offer of shares is a regulated activity in the UK – if you’re not qualified to do it, you’re breaking the law.”

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Scarlett Pierce is Carta’s Product Marketing Manager for the UK and Europe. She joined the team in late 2022 when Carta acquired European equity management startup Capdesk. Prior to Capdesk, Scarlett worked as a digital marketer for brands as diverse as the UK Government, Amazon Alexa and Louis Vuitton.
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