Employee Share Schemes
Starting an employee share scheme means giving your employees a stake in your business. Usually, these schemes are set up to motivate employees, improve retention, and attract new talent.
Employee Share Option Schemes can also help business owners pass ownership to those working. By using such a scheme, owners can slowly sell the company - and maybe enjoy some tax breaks along the way depending on the share scheme setup.
Deciding on the most suitable scheme for your requirements can be difficult as there are lots of different ways to distribute equity. At Lawhive, our network of corporate lawyers is on hand to provide advice on various employee share schemes, including Company Share Option Plans and Enterprise Management Incentive Schemes.
Contact our legal assessment team today to get your free quote for solicitor services and advice.
What is an employee share scheme?
An employee share scheme is a way of distributing company ownership among employers.
Through an employee share scheme, businesses can reward some or all employees with equity in the company. They can also extend this opportunity to external shareholders, like consultants and advisors.
How do employee share schemes work?
Employee share schemes primarily operate through two mechanisms: shares and options. Each offers various scheme types with distinct characteristics.
What are shares?
Shares represent actual ownership stakes in a company and can be granted immediately. There are two types:
Ordinary Shares: These are standard shares in the company that can be given to anyone, including business owners and investors.
Growth Shares: Growth shares are issued at a ‘hurdle price’ which is often at a slight premium to the company’s current value. Recipients of growth shares only share in the company’s growth in value from that point onwards. Growth shares can also be conditions, requiring recipients to meet certain criteria for their shares to become vested and unconditional, provided the company's Articles of Association permit this.
What are options?
Options grant the right to purchase shares at a later date, typically at a predetermined price. These options can be exercised in the future, either on reaching a certain milestone or at the time of an exit event, such as an acquisition or IPO.
Shares vs options: What’s the difference?
The main difference between shares and options is the timing and nature of ownership. Shares represent actual ownership in the company and can be granted immediately, while options grant the right to purchase shares at a later date.
It’s important to understand the difference between shares and options because they impact the timing of ownership, tax implications, and the ability to participate in the company’s growth.
Types of share schemes
There are three main types of share schemes
Share Award Schemes
Share award schemes involve giving employees shares. The value of these shares is considered part of their income and is taxed accordingly unless the plan has been approved by HMRC as ‘tax-advantaged.’
Share Option Schemes
In Share Option Schemes, employees get the right to buy a set number of company shares at a fixed price sometime in the future. Usually, employees can’t exercise these options (buy the shares) until after a certain period, known as the vesting period.
You can also tie the granting and exercising of options to meeting certain goals, like hitting sales targets or creating a prototype.
Share Purchase Schemes
Share Purchase Schemes allow employees to buy shares outright, save money over time to buy shares, or put down a small deposit and pay the rest later to buy shares.
HMRC-approved schemes, like the Company Share Option Plan and the Enterprise Management Incentives scheme, offer tax and National Insurance contribution advantages. On the other hand, unapproved schemes don’t provide these benefits.
However, unapproved schemes are sometimes more flexible because they don’t have to meet the qualifying conditions set for approved schemes.
Phantom Share Option Schemes
Phantom share options are where employees receive rights to cash payments. These payments are worked out on the value of the company’s shares. Instead of actual ownership of the shares, employees get cash based on how well the company performs.
What is a Company Share Option Plan?
A Company Share Option Plan (SCOP) is a scheme where employers can offer employees the opportunity to buy company shares at a fixed price.
In a CSOP, employers can grant employees options on shares worth up to £30,000 each. The share price is set when the option is granted and must be at least as high as the share’s market value on that day.
Employees can exercise their options after a specific period, buying shares at the fixed price, not the current market value.
If employees go on to see the shares for a profit, they may not have to pay income tax or National Insurance contributions on the gains, under certain circumstances. However, they might be liable for Capital Gains Tax if their profits exceed their annual allowance.
Businesses can receive tax relief on the costs associated with establishing and managing the CSOP, as well as on providing shares through the scheme.
What is an Enterprise Management Incentive (EMI) scheme?
An Enterprise Management Incentive scheme lets qualifying companies offer employees options to buy shares worth up to £120,000 per employee (up to a total of £3 million) at a set price.
To qualify, the company’s gross assets must be under £30 million, and it must have less than 250 employees. Certain types of companies, like those in property development or financial activities, don’t qualify. Furthermore, participants in the scheme must be employees working at least 25 hours a week or 75% of their working time. Those owning 30% or more of the company’s shares don’t qualify.
EMI schemes are a popular employee share scheme for private companies.
Are employee share schemes tax-free?
No. In the UK, all shareholders are subject to Capital Gains Tax on any gains from shares. Generally, tax can be due on award, exercise, or sale of shares, with Capital Gains Tax applying to gains in share value and Income Tax being levied at the recipient’s current tax rate.
However, certain schemes offer tax advantages, with recipients benefiting from a lawyer rate on gains over the agreed value set by HMRC at the time of sale, provided it’s at least 24 months after the grant of options.
Further, EMI schemes, for example, can also be cost-effective for employers, offering offsets against Corporation Tax liability. However, it’s important for businesses to fully understand the different tax implications of each scheme.