Successfully leading a startup through those crucial early years is all about finding the right people. At this stage, your employees could make or break your business, and a share scheme is a great way to get talented people on board.
However, finding the time to set up your scheme properly is a challenge. An EMI share plan from Carta is the fast, simple and seamless way to get started. Save precious hours of your own time and avoid unexpected fees by choosing Carta for EMI share plan setup.Our document templates were developed with the experts at Lennon Legal, a law firm specialised in UK share plans. Before launching our service, we sat down with Lennon Legal’s Founder, Gretchen Lennon. Drawing on 15 years of experience advising private companies about share option plans, Gretchen highlighted the key benefits and potential pitfalls of granting equity to employees.
Setting up a share scheme
Gretchen started by emphasising the importance of early-stage companies getting “the right sort of equity incentive plan in place for their business, to ensure maximum incentivisation and reward for their team.”While the scheme has certain parameters, it’s not one-size-fits-all. Each company should design its plan in a way that suits its needs and the needs of its employees. One example is determining the size of the option pool.
“Generally speaking, 10-15% of fully diluted share capital is a good rule of thumb for companies at seed stage or Series A. This will likely be diluted as the company goes through further funding rounds, but investors are aware of the importance of share options to attract and retain talent, so they are usually comfortable with an option pool top-up later.”Gretchen Lennon, Founder, Lennon Legal
Gretchen also flagged the importance of including well-drafted leaver provisions in the option plan rules or share option agreement. “Leaver provisions that are not clearly drafted may be hard to enforce. If they are too harsh, however, they could end up disincentivising the option holders.” She went on to say that companies need to be aware of the distinction made in their share option documentation between good and bad leavers.
Early mistakes can be costly
Over her career, Gretchen has advised businesses of all sizes, from startups and scale-ups to multinational listed companies. With such a vast portfolio, she has witnessed many of the common mistakes made by companies launching employee share schemes.The first hurdle is eligibility. As appealing as the EMI scheme is, it’s all too easy to overlook the qualification criteria. Not all businesses qualify for EMI in the first place, and even qualifying businesses should proceed with caution. Gretchen called attention to “the statutory limitations regarding the types of companies that are permitted to grant EMI options, and the limits on total number of EMI options that can be granted.”
Currently, the maximum value of EMI options that can be awarded to each individual is £250,000, while the total aggregate limit per company is £3,000,000. Any options granted in excess of this limit will not be eligible for EMI tax benefits.
In-built checks are part of the process at Carta, to prevent you from exceeding EMI scheme limits. You'll also be notified when you're approaching the maximum individual or aggregate grant amount, so you can plan ahead.
Another potentially costly mistake that Gretchen has seen is companies making pledges to employees about equity ownership before having a detailed share option plan in place.“I’ve seen employment contracts promising a certain percentage of the company’s shares, without caveating this as being subject to dilution or any specific vesting or leaver provisions.”An oversight like this can have serious consequences. “In some cases,” Gretchen explained, “this gives the leaving employee an enforceable claim over the specified percentage of the company. They could alternatively seek payment equivalent to that percentage of the company’s value, just to settle the claim.”
Follow government guidelines
When asked which elements of the EMI scheme are crucial, Gretchen identified “a clearly drafted vesting schedule and provisions regarding when an EMI option will become exercisable.” She went on to explain that in light of recent updates to HMRC guidance on discretionary terms in EMI option schemes, “it’s more important than ever to ensure the documentation provides sufficient clarity regarding exercise events.”Other changes were announced in the Spring 2023 Budget, signalling a renewed commitment from the UK Government to the EMI scheme and the startup ecosystem in general. As of 6 April 2023, companies no longer need to inform HMRC of “details of restrictions to the shares in an EMI option agreement.” The government has also removed the need to include a working time declaration. “Both of these changes will simplify the contents of options agreements and the process of actually granting EMI options.”“The government also announced that, from 6 April 2024, the requirement to notify HMRC about the grant of new EMI options will no longer be within 92 days. Instead, companies will have until 6 July to notify HMRC of any EMI options granted in the previous tax year.”
A word to the wise
When asked what parting advice she would give to a CEO about to set up their first equity incentive plan, Gretchen recommended the EMI scheme above all else.
“If your company qualifies, always go for EMI. EMI options are the most tax efficient way of granting equity awards to employees in the UK.”Gretchen Lennon, Founder, Lennon Legal
If you’re ready to set up your EMI share plan, Carta can help. Sign up to Carta and you’ll be able to design your scheme, prepare the documentation and begin issuing equity to your employees in a matter of weeks, all on a single platform. Get in touch to arrange a consultation today