This question is often asked by my Digital & Tech clients and other fast growing businesses. The constant threat is that a key team member hands you their resignation as they are lured away from your business by a competitor.
Have to avoid this happening?
A great mission statement, a great team environment, autonomy, flexibility, a great pay structure with excellent fringe benefits all help. We have written more about this in our previous articles: Effective employee benefits don’t have to cost much and How do You Lock in Key Members of Your Team?
But in practice the one thing that could really make a difference is a share in the business.
There are a number of different ways that this can be effected, however there are three key problems:
- Your company has value. If your company is currently valued at £1m then 5% of your company is worth £50,000. A simple gift of that 5% would be considered an event under the Employment Related Security legislation, which is both reportable to HMRC and gives rise to a tax liability on the value of the gift.
- Once the shares are gifted the way your income is extracted will be impacted. If you have one class of Ordinary shares then a dividend to you means a dividend to all ordinary shareholders.
- The shares now belong to the employee. What happens if they leave? Do they keep the shares or do you have a mechanism (a shareholders’ agreement) to get the shares back? If there is no shareholders’ agreement you are now in an even worse position- yes the employee has an vested interest in the success of the company but that interest is there irrespective of their employment. If you have a minority shareholder and no shareholders’ agreement then we strongly recommend you discuss this with either your solicitor or advisor, or alternatively talk to us.
So what is the solution?
There are numerous potential solutions dependent on your circumstances, but one solution which has proved popular with our fast growing clients is the Enterprise Management Incentive Scheme (EMI). We have implemented a number over the years, including one for a software company where employees hold 7.5% of the company’s shares by way of share options.
The EMI scheme is great for incentivising employees but keeps control firmly with the main business owners. No shares are physically transferred initially, instead the employee is granted an option to acquire a fixed number of shares at an agreed value and time. Thus the employee is incentivised to grow the business above this value. The option usually only lasts for as long as the employee stays with the company, and can be restricted so that for example it could only be exercised on a future sale of the whole company.
There will be no income tax or national insurance payable in connection with the grant or the exercise of the option, provided the agreed share price is no less than the market value at the date the grant is made. From a capital gains tax point of view EMI shares have advantages too. In order to claim Entrepreneurs’ Relief (ER) there are two exceptions to the usual qualifying rules:
- The shareholder does not need to own 5% of the company to claim the relief, in fact there is no minimum holding that needs to be disposed of for EMI shares to qualify for ER.
- The holding period starts when the option is granted, not when the option is exercised. That means that provided there are at least 2 years between the date of grant and the disposal, ER can usually be claimed. Effectively exercise and disposal can be on the same day, and quite often is in the case of company buyouts. That way the employee never has to put their hand in their pocket to pay for the shares but pays the agreed exercise price out of their sale proceeds.
A word of warning – there are stringent reporting requirements attached to EMI schemes and failure to comply will result in a loss of the generous tax reliefs.
We would always recommend that you seek professional advice when considering any transactions involving business assets to ensure you maximise the reliefs available and minimise your tax liabilities. If you would like help with locking in your team please contact Jan Friend on 01634 731390 or at Jan@friendandgrant.co.uk.
The content in this blog is correct as at 26/11/19. See terms and conditions.