EOT Transitions and EMI Schemes: Overcoming Key Practical and Technical Hurdles

With more than 2000 UK companies now employee-owned we take a look at some of the practical issues a business owner/founder would need to think about before and after becoming employee-owned in respect of Enterprise Management Incentive Schemes (EMI).

Many of the 180+ EOTs we have helped to complete often also have an EMI scheme. This blog looks to highlight the most common challenges we find and suggestions for how these can be overcome, either for an existing scheme or one created post-EOT.

Before becoming Employee-Owned through an EOT

Companies that operate an EMI or other share scheme such as a Company Share Option Plan (CSOP) before contemplating a sale to an EOT need to consider:

Sale to EOT will typically trigger exercise of existing EMI/other options

Practical 

• In practice, this means the participants will become shareholders for a moment in time before immediately selling their shares to the EOT. This requires these optionholders to become a party to the sale agreement, unless a power of attorney is put in place to smooth the process.
• Participants who have become shareholders by exercising share options will also have to submit their own Self-Assessment Tax Returns to claim the EOT capital gains tax relief which they may not have had to do before.
• There may also be confidentiality concerns about the participants knowing how much the founders have sold their shares for.

Technical 

• From, a technical perspective, companies operating EMI or other share schemes will often create one or more dedicated share classes for this purpose. This can lead to a potential pitfall in that not only any person holding 5% of the Company’s shares overall but also 5% or more of any class of shares will be classed as a ‘participator’. For example, this can mean that a shareholder or optionholder who exercises their option on the sale to the EOT with a very small minority holding can be a ‘participator’ if they hold 5% of a particular class of shares. The impact of being a ‘participator’ is significant in that that they will be excluded from benefiting from the EOT going forward and it will impact on the participator fraction requirement which must not be more then 2/5. Although this will not prevent them from receiving any tax-free bonuses (if they are an employee), they will be barred from any distributions from the EOT itself e.g. of sale proceeds if the EOT sells on its shares in the future.

After becoming Employee-Owned through an EOT

Many employee-owned companies, in addition to the advantages of paying tax-free bonuses to staff, wish to incentivise key employees through awards of tax efficient share options, such as EMI.

Typically, these awards would be granted over newly issued shares which would have the effect of diluting the EOTs shareholding when exercised. It is important that the EOT’s holding never falls below 51% (so as not to become disqualified under the EOT legislation), but subject to that, awards of 5-10% of issued share capital are quite common. Vesting and exercise of the options is often linked to repayment of the outstanding consideration due to the original sellers from the sale to the EOT. This encourages participants to make a success of the business so that these sellers can potentially be paid off earlier or at least on time and also so that participants cannot cash-out before the sellers have been paid off.

If the EOT-owned company would otherwise qualify for EMI options there are a number of other important points to consider:

Corporate Trustee

• Normally, it is recommended for the EOT to have a corporate trustee (the directors of which are in effect the trustees), as this provides greater protection against personal liability than individual trustees and makes the administration easier where there is a change of trustee.

Independence Test

• One of the key EMI eligibility criteria is the ‘independence test’, i.e. that the company is not under the control of another company. Commonly, the EOT will have a corporate trustee which on the face of it would mean that the EOT will not meet this test, but there is a specific exemption in the legislation which ignores the corporate trustee for these purposes. Similar provisions apply in respect of CSOPs, SAYEs and SIPs.
• However, there is a potential pitfall to be wary of depending on the exact type of corporate trustee used. If the corporate trustee, is a ‘private company limited by shares’ it will meet the EMI independence test, allowing for the grant of EMI options in the future. If, however, as is quite often seen, the corporate trustee is a ‘company limited by guarantee’ it will not meet the test, so EMI options will not be able to be granted going forward.

Future availability of corporation-tax deduction

• Another point to bear in mind is the availability of a corporation tax deduction for any EMI or other share schemes operated by the EOT-owned company in the future. If the Company plans to grant options (or potentially other share awards), having a corporate trustee (of any type) will prevent it claiming a corporation tax deduction for participants’ option gains in relation to those options or other gains. If this is a concern, it could be addressed by the EOT instead having individual trustees. This would, though, clearly remove the advantages of having a corporate trustee mentioned above.

Key takeaway

In summary, navigating EMI schemes alongside EOT transitions requires careful planning and a nuanced understanding of both legal and practical implications. Whether addressing pre-EOT sale logistics or post-EOT sale incentives, thoughtful structuring ensures compliance and can maximise the benefits of employee ownership.