This post is part of our Entrepreneurial team’s regular series of blogs.
This year, with the significant ongoing impact of Covid-19, many companies may find themselves unable to offer their employees a pay rise or bonus, instead looking for alternative means to reward and retain their workers.
One excellent method of incentivising employees to stay with the company and participate in its growth is through a share scheme, which can offer generous tax advantages if it is a tax-favoured scheme. Enterprise Management Incentive (EMI) schemes are by far the most popular such scheme.
For companies with an existing (EMI) scheme, or those looking to set up a new share scheme, the current economic uncertainty means this is a great time to agree a share valuation with HMRC. A share valuation, agreed by HMRC, is key to ensuring the EMI option recipients have certainty of taxation consequences.
The normal starting point which HMRC considers when valuing a company is the price paid by any recent (within the last 12 months) third-party investors. This third-party price can then be discounted significantly to account for the minority shareholdings that EMI options are usually granted over, and the enhanced rights that may be given to other shareholders (generally investors) through the Articles of Association or Investment Agreement. Even with a significant discount on the value of the shares from the third-party price, employees can still end up needing to pay a hefty price when the time comes to exercise their options, reducing their eventual gain when their shares are sold.
Companies that had received investment before lockdown and have seen their business falter due to lockdown may be able to argue that the price paid by investors is no longer a fair representation of their share value, with investors having relied on forecasts and business plans which are no longer achievable. This opens the door to using another method of valuation – the earnings basis, for example, which for early-stage companies with significant development costs often allows for much lower valuations than using the last third-party price paid.
Currently, HMRC is also offering companies an extended time frame to grant options once a valuation is agreed. This has increased from the usual 90 days to 120 days. This has helped ease the administrative burden that comes with granting EMI options, as companies and their lawyers have longer to draft option agreements and have their employees sign them, which is currently more difficult than normal with so many working from home.
These factors make this an ideal time to offer employees EMI options. Doing so helps to incentivise key employees who recognise a business’ growth potential to remain in their roles and work to maximise their potential future gains on shares in their employer.
To get a share valuation prepared, and agreed with HMRC, please contact us.