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In this issue of the Corporate Commercial Newsletter:
Our Corporate Commercial team provides focused and practical commercial advice on all aspects of corporate and commercial law. In this newsletter we look at the resurgence of EMI share option schemes and provide a general roundup of recent activity and other developments.
EMI Share Option Schemes
An enterprise management incentive share option (EMI option) is a tax advantageous employee share option granted by qualifying trading companies to selected employees (typically key employees and senior management).
Following the 2012 Budget, EMI options have seen a resurgence in popularity. This is because the capital gains tax (CGT) payable on a capital gain made on the sale of shares acquired via an EMI option will now often qualify for Entrepreneur’s Relief (this reduces the effective rate of CGT to 10%).
Before the 2012 Budget most shares acquired by employees through an EMI option did not qualify for Entrepreneur’s Relief unless the relevant employee held more than 5% of the shares for at least one year prior to selling them.
An EMI option gives an employee the right, but not the obligation, to acquire shares in his employing company. Normally, the employee has the right to exercise the option at a defined price (exercise price) at a particular point in time or upon the occurrence of a certain event (such as a sale or listing of the company) or when certain performance targets have been met.
The EMI option legislation is specifically targeted at small, higher-risk trading companies in order to help them recruit and retain staff. Whilst the tax advantages of EMI options make them attractive, they can also be a cost effective way of remunerating and incentivising key employees. The EMI legislation requires that EMI option terms take the form of a written agreement which states the main terms of the option including how and when it may be exercised. EMI options may be granted under a set of plan rules, or by way of stand-alone EMI option agreements.
There is no income tax liability on the grant of an EMI option. There is no income tax or national insurance (NICs) liability when the employee exercises the option, if the exercise price is at least equal to the market value of the shares at the date the option was granted. If the exercise price is less than the market value as at grant, then income tax and NICs are payable on the difference between the exercise price and the market value at grant. If the market value of the option shares increases between the date of grant and exercise of the option, there is no income tax or NICs liability on that increase in value and such increase is liable only to CGT (which may be as low as 10% if Entrepreneur’s Relief applies).
The tax advantage of an EMI option can be contrasted with the tax treatment of an unapproved share option scheme. With an unapproved scheme, income tax and NICs are payable on this difference between the market value of the shares at the date of exercise and the exercise price (the market value of the shares at the date of grant of the option has no bearing on the tax calculation).
Shares acquired on the exercise of EMI options on or after 6 April 2012 and disposed of on or after 6 April 2013 can potentially qualify for Entrepreneur’s Relief, irrespective of the size of the relevant shareholding. To qualify for Entrepreneur’s Relief, at least 12 months must have elapsed between the date the option is granted and the date of the sale of the shares, in addition to the other company status and employment conditions required to claim Entrepreneur’s Relief.
Aside from the tax advantages, there are a number of other potential benefits that can be derived from the implementation of EMI option schemes. Employees are offered the opportunity to participate in the growth in the value of the company which their hard work may help to create. This is an effective way to engender loyalty and long service amongst key employees. EMI options are normally stated to lapse when an employee leaves his employer or, at the latest, within 6 months of the date he/she leaves.
EMI Qualification Rules
In order to be an EMI option the following rules must be complied with:
- The employer must be a qualifying trading company with less than the full time equivalent of 250 employees and gross assets of £30 million or less (foreign companies can also qualify);
- It cannot be a subsidiary company (usually EMI options are granted by the ultimate holding company where there is a group of companies);
- The maximum value of awards permitted under the scheme are £250,000 per employee and £3 million per company (valued at the date of grant). There is no limit on the number of participating employees;
- An employee must work for the company for at least 25 hours per week or, if less, 75% of his/her working time;
- The option must be capable of being exercised within 10 years of the date of grant and cannot last for more than 10 years;
- Qualifying trading companies are trading companies not carrying on disqualified trades (disqualifying trades include dealing in land, securities or commodities, property development and leasing/hiring businesses);
- Employees with more than 30% of the ordinary share capital of the company cannot participate; and
- HMRC must be given notice of the grant of an EMI option within 92 days of its grant.
Exercise of an EMI Option
Companies have a high level of flexibility when setting the terms of their EMI options. Careful consideration should be given to the circumstances in which the employee can exercise the option. Often, EMI options are structured on the basis that they can only be exercised by the employee if there is an exit event such as a sale of the company or its trade to a third party or a listing of the company’s shares. The employee can then participate in the resulting disposal gain. Structuring the option in this way means that control of the company and any shareholder arrangements (e.g. shareholders agreement and/or the Company’s articles of association) are unaffected until such time as an exit event is about to or has taken place.
Where it is intended that employees should have the opportunity to become shareholders once a certain period of service has been achieved or certain personal performance targets have been met, these requirements can be expressed in each individual EMI option agreement. The option may, for example, be exercisable after a certain number of years’ service or the option may be exercisable in tranches according to completed periods of service and/or when certain financial targets have been met by the employee and/or the company.
If EMI options can be exercised by the employee after a period of service and/or when performance targets are met, careful consideration should be given about the impact that this will have on the company’s articles of association and any necessary changes should be made to the articles at the time of or before the options are granted. If an employee acquires shares before an exit event, then the articles should require him to offer his shares for sale to other shareholders, the company or an employee benefit trust at a defined price when he leaves the company and a “drag-along” provision should be included in the articles so he/she can be required to sell his/her other shares if and when there is a later general exit.
A well designed EMI scheme can provide a simple and valuable way of rewarding future success. However, such schemes are only appropriate in the right circumstances. Before implementing such a scheme, a company should consider the variety of ways that incentivised remuneration can be achieved. Due to the complexity of the issues which need to be considered when planning an EMI option scheme, it is essential to get specialist legal and accounting advice at an early stage.
Corporate Commercial Roundup
Following on from our last Commercial Write, where we gave a positive outlook for the current year and beyond, we have seen continued activity and remain just as confident, if not more, in our outlook.
The total value of corporate, commercial and banking/funding deals that we have been involved in during the last 12 months were in the region of £100m and we expect deal activity in the next 12 months to be in excess of those figures.
The Corporate team has continued to be busy since the start of the year, following the deals completed at the back end of 2012.
Deals are, however, taking slightly longer as buyers and sellers are understandably being cautious. Such approach leads to deals having post-completion adjustments to the price paid (upwards and downwards), as buyers are keen to ensure that they do not overpay and sellers look to secure the full value of the business sold. This takes the form of deferred consideration, earn-outs and completion balance sheet adjustments. More time is also being spent on due diligence, especially where bank/third party funding is involved.
The types of deals we have seen:
- National and cross border transactions involving disposals to foreign/global trade buyers;
- Sales to and refinancing with private equity houses;
- Business angel funding and commercial property funding by high net worth individuals who seek opportunities where banks have left a void.
- We have seen a strong concentration of deals in the IT and professional services sectors.
In amongst all of this, we continue to provide specialist advice in other areas such as business asset protection (shareholder agreements, partnership agreements and joint ventures), reorganisations and restructuring of groups and advising in specialist sectors (for example, we act for a number of solicitors, accountants and other professionals in the health-care industry).
The Commercial team continues to grow from strength to strength in all aspects of commercial law (for example, terms of business and agency and distributorship agreements), and especially with regard to the specialist sectors of IT and IP. The IT sector itself was one of the few sectors which weathered the recent financial crisis better than others as such businesses were able to drive their skills and expertise in an efficient and profitable manner.
The requirements of businesses in such sectors are well catered for by our Commercial team. The service we provide is akin to having “in-house” counsel, especially for large IT companies. However, we also thrive on assisting younger companies making their way and helping them structuring their IT/IP licensing and exploitation models.
- Some of the exciting work we have been involved in includes:
- Negotiating multi-million pound commercial contracts in the insurance, procurement and fashion sectors;
- The delivery of IT systems into the NHS;
- Assisting start-up companies in commercialising their software/IT products and helping them with their suite of documentation to implement the same;
- Advising a trade body in relation to its joint venture project to purchase and operate a recycling plant which offers a specific recycling service, being a first for England and Wales.
Employee owner status
As an aside to our main article on EMI share option schemes, you may also be aware of the Chancellor’s proposal for a new “employee owner” status.
This is where individuals give up certain employment rights in exchange for capital gains tax (CGT) exempt shares in their employer, and is targeted at small and medium sized companies. The Government has recently published the response to the consultation by BIS and, despite the negative response, the proposals are due to come into force on 1 September 2013.
The detail of this proposal is beyond the scope of this roundup (more detail appears in our July 2013 Employment Newsletter) but briefly, the rights given up by an employee include the right to claim for unfair dismissal and the right to a statutory redundancy payment. There are also restrictions on the value of those shares that may be offered with the tax benefits (up to £50,000 of gains will be free of CGT). There are also procedural requirements to satisfy such as:
- Employees having a 7-day “cooling off” period;
- The employer must give information setting out the rights attaching to the shares and the rights the employee is giving up;
- Employees must be given independent legal advice on this (reasonable costs being paid by the employer).
Other issues that should be considered are the administrative costs and the need to consider whether changes are required to the constitutional documents of the employer company. As you will have seen, EMI share options do give substantial incentives to employees (and employers) and we do look sceptically at the potential uptake of this proposed “employee owner” status.
Buy-back of shares
From 30 April 2013, there have been a number of small changes to the buy-back regime (which prevents a company buying back its own shares unless a statutory procedure is followed).
The main changes to the regime introduced by the Companies Act 2006 (Amendment of Part 18) Regulations 2013 include:
- Private companies are now entitled to buy back shares using small amounts of cash (not exceeding the lower of £15,000 or 5% of the share capital in any financial year) where the cash is not identified as distributable reserves provided that the articles of the company permit; and
- A private company can pass an ordinary resolution to permit multiple buy-backs for the purposes of or pursuant to an employee share scheme (previously, each buyback needed to be approved). There are a number of other relaxations in respect of an employee share scheme.
Consumer law update
Each successive Government has promised, but failed to deliver, reform of the UK consumer law regime.
There is however a draft bill (the Consumer Rights Bill) looking to reform, simplify and consolidate the different pieces of legislation currently providing protection to consumers and imposing obligations on suppliers of B2C goods/services.
On 12 June 2013 the Government published the draft bill which includes reforms on:
- Rights and remedies for the supply of goods, services and digital content;
- Unfair terms; and
- Investigatory powers, additional remedies and private actions in competition law.