1. Rewarding employees and
directors with equity
di t ith it
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
Growth | International | Protecting | Restructuring www.taylorvinters.com

2. Rewarding employees and directors
R di l d di t
with equity
Quentin Golder Karl Pocock
Partner Consultant
Taylor Vinters Taylor Vinters
Entrepreneurial Business Team
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

3. Why
Wh equity?
it ?
• Effective incentive:
- studies indicate companies with employee share schemes out-perform
p p y p
companies without, often by significant margins
• Tax advantages:
- for both company and employee
- capital versus income
- NIC savings
• Cashflow advantages:
- a company can provide a benefit to employees without having to fund it with
cash
• Potential windfall gain for employees on exit
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

4. Shares versus options
Sh ti
Shares (pros):
- actual ownership versus right to acquire
- potential for dividends
- voting rights
- right to attend general meetings
- cash commitment from employee
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

5. Shares versus options
Sh ti
Shares (cons):
- shares must be paid for
p
- income tax issues if acquired for less than market value
- what to do if the employee leaves?
- dispersed shareholding can be an administrative hassle
- l
logistical problems on f h investment or sale
l bl further l
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

6. Shares versus options
Sh ti
Options (pros):
- no need for employee to part with cash on grant
- can still provide equity windfall
- on ceasing employment options can lapse
- no issues regarding voting
- can be tax efficient for employer and employee
- flexible – can be made subject to conditions, and tailored to particular
employees
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

7. Shares versus options
Sh ti
Options (cons):
- may not create same sense of commitment
- no voting/dividend rights
- conditions on exercise can be beyond employee control
- if share value drops then essentially unexercisable
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

8. Attitude f i
Attit d of investors to employee
t t l
equity
• Incentivising management/employees generally seen as essential
• Typically a percentage of equity is notionally allocated for employees, eg 10%
employees
• Size of awards to individuals variable depending on size and value of company
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

9. How to t h
H t get shares ( opposed t
(as d to
options) into employee hands?
• Allot at early stage, while values low
• Use HMRC approved schemes eg
- SIP
- SAYE
(but limitations)
• LTIPs (generally only suitable for listed companies)
• Loan to employee to pay for shares (but debt still remains)
• Pay bonus to employee to cover costs of acquisition and tax (fiscally inefficient)
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

10. How to t h
H t get shares ( opposed t
(as d to
options) into employee hands? Cont .
• Allot shares as unpaid (debt remains owing)
• Use of ‘growth’ shares ie shares which only provide a return if certain financial thresholds
shares,
are achieved on a liquidity event. The share rights depress the value of shares acquired
making them more affordable (not always suitable)
• Use of ‘deferred’ shares, ie investor shares converted to valueless shares if certain
milestones achieved, effectively increasing the share percentages of founders/employees
(limited application)
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

11. Use f ti
U of options
• Most flexible and (potentially) tax effective method to pass equity to employees
• For early stage companies in Cambridge the two most typical forms are
are:
- Enterprise Management Incentives (EMI)
- Unapproved options
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

12. EMI options
ti
• Company requirements:
- companies must carry on a qualifying trade in the UK (changes from 6 April)
- “qualifying trade” – trades that are not “excluded activities”, ie dealing in
land, banking, insurance, leasing, legal, accounting, property development,
farming, hotels
farming hotels, shipbuilding
- no more than 250 employees
- gross assets not more than £30m
h
- independence – not a subsidiary of another company
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

13. EMI options
• Company requirements:
C i t
- limit of £3M (based on market value of shares subject to options at their date of grant) of
issued options outstanding.
p g
- shares must be fully paid and non-redeemable

14. EMI options
ti
• Eligible employees:
- must not hold options over shares in excess of £120k at date of grant
- 30% material interest threshold
- minimum work time commitment (25 hours per week, or 75% of working
time)
• Options must be exercised within 10 years
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

15. EMI options
ti
Benefits:
• Flexibility – as to voting, conditions of exercise, price
voting exercise
•Tax position:
- no income tax on grant
- no income tax on exercise if:
(a) a qualifying option; and
(b) there was no discount to market value at date of grant
- on sale of underlying share – CGT at 18%
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

16. Potential
P t ti l problem with EMI options
bl ith ti
• Disqualifying events, eg company or employee ceases to meet EMI requirements. Tax
benefits lost unless option exercised within 40 days.
• Disqualifying event occurs:
- may not be realised at time
- if the option is subsequently exercised, there can be adverse tax
consequences if the parties are unaware of its non-qualifying status
- if not picked up, then liability may b ld significantly
f k d h l bl build f l
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

17. EMI options – tax example (1)
• Option
O ti over 100 shares at £50 per share, so exercise price is £5 000
h t h i i i £5,000
• Market value at date of grant is £50 per share, so £5,000 in total
• Market value at exercise is £300 per share, so £30,000 in total
• Income tax due on exercise £0 (assuming exercise within 10 years and a qualifying option)
• On sale of shares, capital gains tax due on difference between exercise price and sale price

18. EMI options – tax example (2)
• Option
O ti over 100 shares at £50 per share, so exercise price is £5 000
h t h i i i £5,000
• Market value at date of grant is £100 per share, so £10,000 in total
• Market value at exercise is £300 per share, so £30,000 in total
• On exercise income tax due £5000 (ie difference between exercise price and market value at date of
grant)
)
• On sale of shares, capital gains tax due on difference between market value at date of exercise and
sale price

19. EMI options – tax example (3)
• Option
O ti over 100 shares at £50 per share, so exercise price is £5 000
h t h i i i £5,000
• Market value at date of grant is £100 per share, so £5,000 in total
• Disqualifying event occurs (when market value is still £5,000), and option not exercised within 40 days
• Market value at exercise is £300 per share, so £30,000 in total
• On exercise income tax due on £25,000 (ie difference between exercise price and market value at
date of disqualifying event)
• On sale of shares, capital gains tax due on difference between market value at date of exercise and
sale price

20. Unapproved options
U d ti
• Completely flexible as to terms
• Options can be granted over any type of shares, at any price, with whatever exercise
shares price
conditions as the company may impose
• No restriction on who options can be granted to
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

21. Unapproved options
U d ti
• Tax treatment
- no income tax on grant
- on exercise income tax on the difference between the exercise price and
exercise,
the market value of the share on exercise (less anything paid for the grant of
the option)
- tax charge on exercise arises whether or not shares sold
h h h h ld
- on a subsequent sale of the shares, CGT will be payable
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

22. Restricted h
R t i t d shares
• Tax treatment
- “restricted shares are subject to a specific tax regime when granted to
restricted shares”
employees or directors
• What are “restricted shares”?
- shares are restricted if:
(a) they can be forfeited in certain circumstances (eg on leaving the
company) )
(b) a right over, or conferred by, shares is limited (eg have to sell shares to
specific purchasers); or
(c) the shares impose a disadvantage on the shareholder
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

23. Restricted h
R t i t d shares
• Purpose of regime?
- without specific tax regime, income tax could be avoided by artificially
reducing share values and increasing them at a time when income tax is not
payable
- rules can apply to innocent transactions so care needed
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

24. Restricted h
R t i t d shares
• How are restricted shares taxed?
- income tax is not chargeable on acquisition except in limited circumstances
- if restricted shares are acquired for less than their unrestricted market value
income tax is charged when either:
(a) the restriction expires or is lifted or varied; or
(b) the restricted shares are sold with restrictions in place
- income tax is chargeable on the proportion of the unrestricted market value
at the time of the taxable event, less any allowable expenditure
- PAYE may be operated and NICs charged depending on facts
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

25. Restricted h
R t i t d shares
• Example of income tax charge
( )
(a) unrestricted market value of the shares on acquisition is 100
q
(b) restricted market value of the shares on acquisition is 70
( )
(c) discount is 30% (
(the “chargeable p p
g proportion”)
)
(d) unrestricted market value on disposal is 200
(e) income tax chargeable on 60 (ie 30% of 200)
- more complicated if only one of a number of restrictions is lifted, but can
elect to treat all restrictions as lifted at that time
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

26. Restricted h
R t i t d shares
• Income tax when shares have decreased in value
- Example:
(a) unrestricted market value on acquisition is 100
(b) restricted market value on acquisition is 70
(c) discount is 30% (the “chargeable proportion”)
(d) unrestricted market value on disposal is 50
(e) income tax chargeable on 15 (ie 30% of 50)
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

27. Restricted h
R t i t d shares
• Alternative tax treatment
- employer and employee can jointly elect for different tax treatment
• What effect does an election have?
- employee subject to income tax at time the shares are issued
- tax charge is based on the unrestricted market value of the shares less the
price paid
- no further income tax will arise when restrictions lifted or shares sold
(although CGT may be payable)
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

28. Restricted h
R t i t d shares
• Should you make an election?
- Pros:
(a) upfront tax charge is known and may be affordable
(b) potential tax saving if unrestricted value increases considerably
- Cons:
(a) employee may forfeit shares even though paid the tax
(b) shares may not increase in value so tax paid higher than if no election
(c) will have to find cash as no disposal proceeds
LAWYERS
WITH A
CAMBRIDGE
ATTITUDE
www.taylorvinters.com

29. Taylor Vinters
Merlin Place
Milton Road
Cambridge
CB4 0DP
01223 423444
Taylor Vinters is regulated by the Solicitors Regulation Authority (SRA Number 67782) and is authorised and regulated by the Financial Services Authority for investment
business. This firm is regulated by the Solicitors Regulation Authority and authorised and regulated by the Financial Services Authority for investment business. www.taylorvinters.com