Is EMI Reform Around the Corner?

What’s happening?

The UK Government is reportedly considering increasing the individual limits for Enterprise Management Incentive (EMI) share options.

Currently, individuals can hold options over a maximum of £250,000 of shares in any three-year rolling period. While not yet confirmed, initial reports suggest the individual limit could be increased by “a multiple” of its current level, meaning we could see a substantial increase in the number of shares that individuals can hold.

What are EMI options, and why does the news matter?

EMI options are widely considered to be the ‘gold standard’ for tax-advantaged option plans in the UK for smaller private companies with gross assets of under £30 million. If set up and operated correctly, there is income tax relief on the exercise of a qualifying EMI option.

Subsequently, when the shares acquired on exercise of a qualifying EMI option are sold, any gains made are subject to capital gains tax (potentially with additional Business Asset Disposal Relief available, even for shareholders under 5% on the cap table). This makes EMI option plans highly attractive to start-up, early stage, high growth and VC-backed companies looking to incentivise their key employees into the next phase of business growth.

Both companies granting EMI options and employees receiving them are subject to strict, complex eligibility criteria, including the £250,000 individual limit based on the value of the shares at the time of grant for EMI options in any three-year rolling period. This limit can create pinch-points for the high-growth, early-stage companies that EMI targets, which need top-level expertise to drive business growth but don’t yet have the cash flow to pay suitably high salaries.

It also means that EMI options become less relevant for companies as they scale following later-stage fundraises, which drive up market value, meaning a £250,000 individual limit at grant is very quickly utilised. Companies are then forced to consider other incentive arrangements, such as growth shares. Whilst these are practical alternatives, they introduce an additional layer of complexity in the cap table and articles.

An increase to the EMI individual limit would help to alleviate this squeeze and open the door to more early-stage companies maturing successfully under the expertise of top-level senior leadership. It would allow companies to utilise their EMI plans for longer and make them amenable to all multiple grants at various stages of a company’s life cycle.

What questions remain?

The Government has not confirmed if it will increase the EMI individual limit and is unlikely to confirm its position before the next budget, currently set for the end of November. Amidst speculation about further tax raises and spending cuts, increasing the EMI individual limit would be a welcome boost to small businesses trying to grow in a challenging environment. However, practitioners will have fundamental questions about the implementation of any new limit:

1. Will any increase to the EMI individual limit also allow the retrospective modification of existing plans to increase individuals’ limits? While some companies’ EMI plans will have been future-proofed from the outset, this will be a concern at the forefront for many companies that have outstanding grants of EMI options that they wish to increase; and
2. Will the company limit for the total value of EMI options in issue increase proportionally to the individual limit? Companies currently face a £3 million cap on the value of shares under EMI options at any one time. A significant increase in the individual allowance would consume that £3 million cap much faster, meaning companies could end up facing the same problems as they currently do, just for different reasons.

How can Orrick help?

Orrick’s UK Compensation and Benefits team is at the forefront of the market for EMI share option plans, regularly advising a broad range of clients on their design and implementation. If you are thinking about introducing an EMI option plan, or any other form of employee incentive arrangement, our team is well-placed to guide you through the process.