What to do if EMI is not available…

Amanda Flint

Contact:T: 07786 967577E: af@amandaflint.com or from 1st July2012 amanda.flint@uk.gt.com

EMI is not available…

This may be because: Your Company does not qualify (this might be

because your trade does not qualify; or The individual that you want to benefit does not

qualify e.g. not working enough hours; or Your shares do not qualify; or You have too many employees.

You can use EMI but you have no more capacity (now personal limit of £250k per person – measured at grant)

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First step: go back to your objectives

“The executives should be treated as investors – we would like them to put up cash into the company”

“We want our directors to demonstrate commitment by ‘pay to play’ but we understand that they are at a stage in their lives where they are cash poor!”

“We know that our management team is key to our future success and we want them to share in the growth it has created”

“I want executives to participate in a future exit – but not until then”

“I am keeping a tight control on cash and so it is important that the directors have a meaningful long-term incentive”

“Achieving capital gains tax treatment is an important financial element of the incentive for executives.”

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Ask some questions:

Valuation is key – don’t forget the minority share holder discount!

What is the realisation point – exit? Or earlier? Who will fund an earlier exit?

What do you want to happen if a participant leaves? Will there be future generations of executive to

participate in the incentive – Or are you mainly focused on the current executives?

Are you prepared to make the incentive valuable from the outset?

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Solution 1 –share subscription

Objectives: Executive – little cash Pay subscription price of

nominal value Get shares up front –

benefit from future growth Can add conditions to

shares – forfeit if leave employment

Need tax election

COMPANY

EXECUTIVE

CashShares

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Implications & Use – share subscriptionImpactAny difference between nominal value & market value is subject to income tax;Often no PAYE/NIC – but depends on circumstances;No advance valuation can be agreed with HMRC & may have to wait until self assessment tax return is submittedExecutive is a shareholder

Useful where:The value (for tax purposes!) is very low – it will not have NO value;The nominal value of the shares is low;You want the executive to be a shareholder;The implications if they leave are well thought through – i.e. who will buy the shares, at what price

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Points to note – share subscription Probably helpful to undertake a valuation exercise

at acquisition – HMRC tend to use hindsight! Limited shelf life – as the company grows, shares

will become more valuable & entry cost will become unattractive

Uncertainty of tax treatment will not suit very cautious executive

But: part of shareholder ‘team’ from the outset

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Solution 2 – partly paid shares

Objectives: Executive – little cash Acquire shares at current

market value – but leave subscription outstanding

Get shares up front – benefit from future growth

Can add conditions to shares – forfeit if leave employment

Tax election prudent

COMPANY

EXECUTIVE

Shares Owes subscription price

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Implications & Use – partly paid sharesImpactNo up front acquisition cost;No up front income tax charge – but may be on going taxNo advance valuation can be agreed with HMRC – may need adjuster clauseShares subject to a call – tax due if disposed of without paying upExecutive is on risk for an amount equal to market value on acquisition

Useful where:You want the executive to buy shares at market value but they have no cash available;The exposure level is acceptableYou want the executive to be ‘on risk’ – pain as well as gain!There is an exit likely at some pointThe implications if they leave are well thought through – i.e. who will buy the shares, at what price

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Points to note – partly paid shares Probably helpful to undertake a valuation exercise at

acquisition – HMRC tend to use hindsight! Can use an Employee Share Trust to buy shares later if

necessary Recent tax changes mean that now need to use new

issue shares only Very difficult to unscramble – tax cost of exit even if

value falls

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Solution 3 – loan to buy shares

Objectives: Executive – little cash Acquire shares at current

market value Get shares up front – benefit

from future growth Can add conditions to shares –

forfeit if leave employment Tax election prudent

COMPANY

EXECUTIVE

CashShares

Cash

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Implications & Use – loan to buy sharesImpactSame as partly paid but:

Not subject to a call on shares

Easier to write off loan if you wish to do so in the future

Useful where:Same as partly paid but:

Where you might want to release executive from obligations in certain circumstances (e.g. hardship, extreme economic conditions, death)

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Points to note – loan to buy shares Same as partly paid but:

Recent tax changes mean that loan should not come from a third party unless it is a commercial loan

Easier to write off loan – so long as this is lawful for insolvency law purposes

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Solution 4 – flowering shares

Objectives: Executive – receives shares

up front whose value ‘blossoms’ if conditions are met;

If conditions are met – restrictions fall away;

Can be forfeited if leaves employment etc.

EXECUTIVE

Unrestricted share value

Pays subscription price & receives

shares

‘Flowering’ share value

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Implications & Use – flowering shares

ImpactTax trap: If you don’t pay the full unrestricted share value when you acquire the shares, there will be income tax to pay when you sell them

Can make election and pay income tax up front on value you may not receive; OR

You can pay income tax when you dispose of the shares – value could be much higher

EXECUTIVE

Unrestricted share value

‘Flowering’ share value

TAX TRAP

Pays unrestricted share value or ‘Flowering’ share value

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Points to note – flowering shares Still useful if tax is not the main issue Need to manage expectations & communicate

regularly and clearly on the tax treatment May be helpful where share value is low and

entry cost is also low Can combine with loan

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Solution 5 – growth shares

Objectives: Executive – receives shares from a new class that only has

value if company value grows Value low – whether or not restricted (may be hurdle); Can be forfeited if leaves employment etc. – will need to use

tax election on acquisition for tax benefits

EXECUTIVE

Ordinary share capital

Growth shares

Ordinary share capital

Growth shares created

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Implications & Use – growth sharesImpactNew class of shares – amend articles of association;No advance valuation process with HMRC but a valuation exercise advisable – may be able to agree with HMRC afterwards;Executive a shareholder from the outset

Useful where:The current share value is high but you want to reward executives for future performance;You want executives to become shareholders from the outset;There is a change of ‘generation’ at the company

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Points to note – growth shares

The new class of shares and the corresponding low value has a short shelf life – especially in a fast growing company;

If you will have a train of new joiners over the next few years – you may need to create a new class of shares periodically – which may mean a very complicated share capital structure;

This could make communications on value opaque and might also make an exit complicated

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Solution 6 – joint ownership

Objectives: Executive – receives future growth on existing ordinary shares Value low – whether or not restricted (may be hurdle); Can be forfeited if leaves employment etc.

EXECUTIVE

Ordinary share – current value

Ordinary share – future value

Trustee

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Solution 6 – joint ownership – additional feature

Objectives: Unapproved option over existing value to executive; Subject to income tax on exercise – but value fixed at award; On vesting, executive gets ‘whole’ value of share – initial

value subject to income tax, growth subject to capital gains tax – similar to LTIP

EXECUTIVE

Ordinary share – current value

Ordinary share – future value

Trustee Unapproved option

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Implications & Use – joint ownership sharesImpactNo need for a new class of shares – keeps share capital structure simple;Can adjust hurdle to regulate up front costNo advance valuation process with HMRC but a valuation exercise advisable – may be able to agree with HMRC afterwards;Executive a shareholder from the outset

Useful where:The current share value is high but you want to reward executives for future performance;You want executives to become shareholders from the outset;It is likely that you will have a number of senior hires over the next few years

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Points to note – joint ownership shares Simplicity of share capital structure attractive if there is to

be a later exit; Not time sensitive – can adjust as time progresses; Use of trustee adds third party validity to the

arrangement; Up front tax charge unless pay market value for future

interest of shares; Valuation exercise strongly recommended

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Summary

There WILL be tax implications – and these cannot be left to the individual as the company will have liabilities – advice is essential

Don’t forget compliance issues for the company – non-reporting implications can be a high corporate cost!

Any non-UK element will need additional tax & legal consideration

Up front planning and on-going communication to executives are EQUALLY important

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