Life sciences A to Z - O is for (Employee Share) Options

Enterprise Management Incentives (EMI)

Tax is also always an important consideration in any plan, but this is particularly so with private companies.

In the UK, the most favourable and popular arrangement with private companies is the EMI option scheme and life sciences spin-outs and start-ups are no exception. Awards here are normally only made at senior employee level. Gains resulting from options awarded under this plan can be subject to tax not as employment income but as a capital gain, often at a favourable rate if the option has been held for at least two years (14% if shares are sold before 6 April 2026 and afterwards at 18%). Options are normally only exercisable on a sale or other exit event for the company.

While there are great tax savings for executives who can receive these options, which can be granted over up to £250,000 worth of shares, they come with some narrow eligibility requirements and a heavy compliance regime.

• Only companies which are not controlled by another company can make awards. This excludes companies owned by a fund or which have a controlling corporate shareholder from being able to use the plan.
• The plan cannot be used to make awards if the company has group gross assets of more than £30 million or 250 or more employees. The plan cannot be used to make awards if the company has group gross assets of more than £30 million or 250 or more employees. However, pre-Budget briefings have suggested that these may rise in the November Budget, which would be a huge boost to the scheme.
• Although the award paperwork can be straightforward, the general need to obtain an agreed valuation from HMRC (the UK taxation authority) for the value of shares at the time of an award is a timetabling issue that needs to be factored in.
• In addition, as HMRC only respond to a proposed valuation, there is usually a need to instruct an external valuer to reach this value for HMRC to approve.
• There is also a need to notify options to HMRC. Historically this had to be done within 92 days of the grant of the option, but the reporting deadline has changed so that an option now just has to be notified after the end of the relevant tax year in which the option was granted. Keeping screenshots is important as HMRC do not respond to acknowledge a notification nor is there the ability to contact HMRC to ask for a list of notifications.

These issues are usually most closely addressed on due diligence at the time of an exit particularly if option gains are high, and so it pays to be prepared when granting options so that all relevant paperwork is subsequently in order and to hand. If options do not qualify or relevant evidence is not available, not only may companies have disappointed employees, they may also have PAYE (the UK form of employer withholding on employment income) exposure, although HMRC, to be fair, can be very "pragmatic" in these situations, and so it is certainly worth asking for their indulgence, even though this cannot be guaranteed.

In our experience, many private company exits in this sector see compliance issues. This just emphasises the need for plans to be carefully operated so as not to risk the large rewards these plans offer successful companies and their employees.

Other plans for private companies

As mentioned above, EMI plans are not always available. In that case, companies can choose to operate other option plans, though employee gains are likely to be taxed as employment income in these cases as capital gains treatment is only available under one of these other arrangements (the CSOP), and even then the CSOP cannot be offered if the company is not an independent company.

Another popular scheme, which has risen in popularity over the last few years, is to award employees what are known as growth shares. These are a special kind of share which the employee holds from the outset with employees usually having to pay only a small amount to receive the shares. They usually have no voting, dividend or other preferential rights, but on an exit receive a share of sale proceeds above a hurdle level (usually slightly above the value of the company when shares are awarded). This plan offers many of the economic returns of an option but the return will still be taxed as a capital gain, and this plan can importantly be offered by any company.

Quoted companies

Quoted companies can in some cases operate EMI or other option plans, and can even offer growth share arrangements, but they tend to operate different plans at executive level in the form of free share plans, generally without any tax benefits.

Awards in quoted companies tend to be made annually to executives as opposed to a single award in a start-up situation and due to the size of companies often to a much larger group of employees. Under these plans (which come under a variety of names, LTIPs or RSU plans being the most common) employees pay nothing or only a minimal amount to receive shares. The shares are automatically delivered on fixed anniversaries of an award date (so long as an employee remains in employment) although the number of shares received can sometimes also be dependent on the extent to which performance conditions have been met between the grant of the award and receipt of shares. As there is usually a ready market for the shares, once received, the shares can be sold freely (including the sale of shares to meet any tax requirements). Unlike with private companies, there is no need to wait until there is an exit for the business.

Most quoted company share plans are fully subject to PAYE due to most quoted companies being too large to offer EMI plans and CSOPs having a relatively small individual award limit. However, tax favourable awards can often be made to all employees under HMRC’s two all-employee plans. Awards can either be made as free shares or through employees saving for shares, but these plans have small individual limits. Due to their implementation costs, these plans are not really practical in smaller quoted or private companies. Often non-UK headquartered companies, particularly US and French companies, may already offer their own national equivalents which can be adapted to meet the UK requirements.

The scale of the award process is often such that awards and receipts of shares are managed externally through an employee portal which can enable employees with just several clicks to accept awards or take out and sell their shares within minutes, including selling the number of shares to pay the required amount of tax. However, operating share plans in a quoted environment clearly brings with it insider dealing and other issues which need to be taken into account in this process.

Finally, whether private or quoted, two key areas to address are:

1. Leaver issues
    
   In most cases, employees who leave will lose their awards, which will lapse. However, this is not always the case and companies usually categorise leavers as either "good" or "bad" leavers. Good leavers will usually include death, illness, redundancy and other leavers who the company choose to put in this category, with resignations and dismissals normally classed as bad leavers unless the company decides otherwise.
    
   While bad leavers lose outstanding awards without any compensation, good leavers normally keep their awards and can sometimes receive shares early, though may not be able to receive the full number of shares which they might have received had they remained in employment.
    
   While each company will have different terms and policies, the loss of any award and/or the ability to retain it can be contentious terms in any employee exit arrangements, when the quantum concerned can be considerable.
    
2. International arrangements
     
   Larger companies are likely to have at least some international element to their share plans. We regularly advise both UK companies offering awards to group employees based outside the UK as well as international companies offering awards to their UK employees.
    
   Aside from each country having different tax and securities law issues which need to be checked, practical issues such as translations, exchange control, and currency and other issues in connection with the buying or selling of shares in different jurisdictions and on different stock exchanges need to be bottomed out to avoid unintended consequences. The law can also sometimes change between an award being made and shares being received some time later and so it is good practice to check nothing has changed before any award leads to shares being delivered.

Please get in touch with us if you have any questions on employee share options or employee share plans.