Incentivising key employees by giving them an equity interest in the company not only makes sense from a motivational and employee retention perspective but it also makes good financial sense when cash is tight and bonuses will trigger heavy tax liabilities.
Many fairly new UK companies will qualify for the Enterprise Management Incentive Scheme (EMI scheme) which is a tax favourable share option scheme which allows qualifying companies to allow selected employees to share in the success of the company, usually on an exit.
Companies that qualify for EMI may also qualify for EIS (Enterprise Investment Scheme). EIS is a tax break available to new investors in the sorts of companies which would qualify for EMI options.
There is normally no problem in a company acquiring funding under EIS while incentivising key management or employees using EMI, however, one possible trap is that EIS is only available in respect of new ordinary shares which do not carry preferential rights. This condition is relevant for three years after the date of the EIS share issue and therefore the risk would be that the EMI option holders could end up with restricted shares (eg with bad leaver provisions etc) which would suddenly (by definition) give the EIS shareholders preferential rights and blow their tax reliefs out of the water.
One possible solution is to make sure that EMI options are issued over the class of shares which makes up the EIS investments. Another is to ensure that no EMI options are exercisable during the three year period after the EIS investment (and therefore no restricted shares are in issue during this period). Sometimes this will not be commercially feasible and where this is the case it usually makes sense to seek (non-statutory) clearance from HMRC that they accept that the EIS shares will not carry preferential rights as a result of any EMI exercise. From our experience the clearance team usually take a pragmatic stance and react quite favourably to these kinds of queries.
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