Setting up an share option scheme used to be complex and expensive. We just changed that.
First, a recap of the 3 things needed to give share options to your team.
You generally only create the last of these, the Share Option Scheme, after you’ve created an Option Pool and promised share options to your team in their employment or advisor agreements, always with a vesting schedule of course. So we’ll assume you’ve done the first two already, and you're now looking to create your Share Options Scheme.
The next thing is to figure out which type of Options Scheme you want to create. Here’s the background:
When you give someone options, and even when the options vest, no tax gets paid by either the team member or the company. Easy.
- But when the options are exercised (i.e. the person pays a nominal amount to convert their options into shares), the person is liable for capital gains tax on the difference in price between the ‘strike price’ (usually a few cents per share) and the actual share price at that time.
In the case of a consultant or advisor, that capital gains tax is their problem, in the same way that paying income tax on their income is their problem.
But, if the person exercising the option is a PAYE employee, then the difference in value between the exercise price and the current share price will be treated as a benefit that the company is providing the employee, and not only will the employee have to pay capital gains tax, but the company may become liable to pay National Insurance and other taxes. So giving employees shares the wrong way can be a very expensive mistake!
To avoid this company expense, HMRC has helpfully created something called an EMI Options Scheme. The idea is that you agree a company valuation with HMRC at the time the options are granted. And then when the options are exercised the employee only pays entrepreneurs' relief on the value of the options above that valuation, and the company pays no tax on the options at all.
This tax-advantaged scheme, as it’s known, is only available to PAYE employees.
Everyone else (contractors, advisors, etc.) can’t use this scheme, and instead they get what’s called an Unapproved Option scheme, so named because the company valuation hasn’t been approved with HMRC.
- an EMI Options Scheme is for PAYE employees only.
- an Unapproved Options Scheme is for consultants, advisors, etc.
Both schemes start out with pretty much the same legal documentation, but where they differ is that with the EMI Options Scheme you additionally need to agree a company valuation with HMRC.
While in theory you can do that yourself, as a practical matter you really need an accountant to help come up with, or at least justify, the company valuation.
The whole EMI Options Scheme application needs to be choreographed quite carefully:
- Team members are promised options that will be granted “when the options scheme is put into place”
- Some months later, you get round to creating your Options Scheme, as you're presumably looking to do right now.
- The Options Scheme is approved by the company Board
- You work with an accountant to agree a company valuation
- Your accountant submits the valuation to HMRC
- HMRC approves the valuation
- You now grant the options to your team, which needs to be done within 90 days of the valuation being approved.
- And you need to let HMRC know about the grant of those options within 92 days.
The combination of legals (for the options agreement), HR/legals (for the employment agreement), accounting (for the valuation) and HMRC approvals (for the valuation) have historically made this a complex and expensive process.
At SeedLegals we’re setting out to change that!
You can build create both an EMI and an Unapproved Option Scheme at no extra cost, so you can give options to employees, advisors and contractors without worrying about the cost of creating multiple plans. And your team members will get online access to all the paperwork, and you’ll delight them with a beautiful share option certificate to download and keep.
So, welcome to the new way of doing a Share Option Scheme – now available on SeedLegals.