An Employer’s Guide To Employee Share Option Plans

Employee Share Option Plans (ESOPs) are an attractive option for many startups and small businesses.

If you’re thinking about establishing an ESOP for your company, read on to learn:

• What is an ESOP?
• What types of ESOPs are there?
• How are they taxed?
• How to set up an ESOP and;
• The pros and cons of an ESOP

What Is An Employee Share Option Plan?

An ESOP gives your employees the option to buy an interest in your company. You can structure an ESOP in different ways, choosing how employees can pay for the shares and what kind of shares the employees are entitled to.

This might sound like Employee Share Schemes (ESS). The main difference here is that an ESS directly issues employees with shares, whereas an ESOP gives you the option to acquire shares under a certain arrangement or plan.

There are four main types of tax-advantaged share schemes:

1. Share Incentive Plans (SIPs)
2. Save As You Earn option schemes (SAYE)
3. Company Share Option Plan (CSOP)
4. Enterprise Management Incentives (EMI)

It’s important to note that tax benefits can apply to certain share schemes. If the share scheme is not within the scope set out by HMRC, then tax benefits will not be available.

Generally, ESOPs are a great method of incentivising employees to stay with your company by introducing the option to buy shares.

How Do I Set Up An EMI?

An EMI is a popular option for businesses because it’s very tax-efficient. So, where do you start?

Before you think about the first step, you need to make sure you’ve satisfied the relevant requirements. For example:

• Your business needs to have fewer than 250 employees when the options are being granted
• You need to firstly get you strike price approved by the HMRC and, subsequently, notify the HMRC within 92 days of granting the options
• The people receiving the options must be employed by the business (so no consultants or Non-Executive Directors)
• The options cannot be transferred

These are only some of the requirements you need to be aware of before setting up an EMI, so it’s a good idea to do a bit more reading and chat with a lawyer who can help you out.

Once you’re eligible, you’ll need a set of rules that basically go through relevant processes. For example, what will happen when an employee leaves? What are the vesting provisions? How will the shares be valued?

You’ll also need a valuation report, which you then need to give to HMRC. After this, you’ll need to distribute paperwork to. your employees which disclose the details around the option agreements.

This can be quite an overwhelming process, but it doesn’t have to be. It’s always worth speaking to an expert lawyer who can walk you through each step so you don’t miss anything important.

How Are ESOPs taxed?

Like we mentioned, share schemes can be taxed or not taxed. If it is an ‘approved’ scheme under HMRC, then tax benefits will apply. In other words, recipients of shares won’t need to pay income tax or Capital Gains Tax.

However, these benefits will only be available to employees if they meet the criteria set out by HMRC. For example, if you want to set up an EMI that is eligible for tax benefits, the shares offered need to be ordinary shares.

Another requirement is that the person exercising the option needs to be an employee. So, they can’t be a consultant or a non-executive director who isn’t directly employed by you.

It’s important to understand the differences between the four types of ESOPs as the tax requirements differ slightly for each one. For example, under an EMI, recipients don’t actually have to pay income tax when they exercise their option if the price they paid when they bought the option initially is less than the market value.

Are ESOPs Worth It?

Like anything, ESOPs have their advantages and disadvantages. To help you decide if they’re worth it for your company we discuss pros and cons below.

Pros

• An ESOP aligns the interests of the company and the employees. Providing another level of incentivisation for your employees to work hard.
• An ESOP can relieve the pressure of offering competitive salaries to attract talent
• An ESOP is also a good way to retain talent, as employees are invested in the company they are more likely to stay.

Cons

• All such incentive schemes have administrative and start up costs. 
• If the company loses value employee motivation and morale could be weakened.
• An employer must consider the loss of control that is inherent in distributing equity of a company. 
• Equity can be a complex to understand and often employees don’t fully appreciate the value of options or shares (until the company exits and they get paid!)

Will I Need Legal Assistance/Advice When Creating An ESOP?

Setting up an ESOP is a complicated process. Any mistakes you make along the way could cost you more in the long run, so it’s better to seek advice and get it right.

Getting advice from a lawyer and accountant would ensure your ESOP is set up to get the best outcomes for your company.

Need Help?

We can help with this! If you need help establishing your incentive schemes, we’ve got you covered. You can reach out to us at [email protected] or contact us on +44(0)2034321860 for an obligation-free chat.

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