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What happens to EMI options if an employee leaves a company?

EMI (Enterprise Management Incentive) schemes are frequently employed by rapidly growing small businesses to attract, inspire, and retain their workforce. However, what happens to EMI options on an employee exit?

There are generally 3 routes when an employee leaves a company:

  1. Lapse – this means an employee loses the EMI option and the reward entirely.
  2. Keep – this means that an employee’s EMI options run until an exercise event such as an exit.
  3. Exercise – this means that an employee can exercise the EMI options and buy shares in the business.

What documentation do I need to look at to see how the EMI option will be treated?

You should look at the share plan rules and the employee’s option agreement to see how the option will be treated. These might be hosted on your company’s share plan portal. The key point to note is that generally the treatment of leavers will have been decided when the share plan was set up and/or the grant was made. This means there may be limited opportunity to vary what the documentation says at the employee exit, particularly if the company wants the employee to keep the EMI tax breaks.

Are there any deadlines I need to be aware of?

There may be which is why it’s important to check the documentation. If employees can exercise their option when they leave the business, often there is a limited period in which they can exercise your option, typically 90 days, and if they miss this window the option may lapse.

Are there different consequences depending on whether the EMI option is “vested”?

There can be. An option may “vest” when a service condition is met as it’s a reward for service. The plan may provide vested options may be exercised or continue as they represent a reward for past service. Unvested options which are a reward for future service may lapse.

What are good and bad leavers in EMI options?

These are badges for the circumstances of the employee exit. The reason for differentiating between leaver types is that the treatment of the option differs.

Where there are good and bad leaver provisions, generally good leavers will be allowed to keep or exercise their option to an extent, and bad leavers’ options will lapse.

Good leavers will usually include “involuntary leavers” such as leavers by reason of death, ill-health, illness, redundancy and the sale of the company or business in which the employee works.

Bad leavers are often leavers who resign particularly if they leave to go to a competitor.

Sometimes there may also be a category of “very bad leavers” who are leavers by reason of gross misconduct, for example fraud.

If an employee can exercise the EMI option, how will they fund the exercise price?

This can be a barrier to exercise. Usually on a transaction the exercise price is funded from the cash payable to the seller for the underlying shares. On an employee exit, there is no liquidity event to fund the exercise price so usually employees will need to self-fund the exercise price. In deciding whether or not to exercise the option, the employee will need to consider any risks of holding unmarketable shares in a former employer.

Are there any tax consequences to be aware of when a leaver exercises their EMI option?

There are a few relevant considerations, some relating to the leaver and some the company.

For the leaver

First, this will depend on the exercise price of the option and whether it is less than the market value of the underlying shares at the date of grant. If it’s less than the market value of the shares at grant (it’s quite common to have EMI options with a nominal exercise price), the leaver will be assessed to income tax at exercise on the discount to the market value at the date of grant.

Second, this will depend on when the leaver exercises their option. If they are able and do exercise their option within a short period of leaving employment, there should be no additional income tax consequences to consider. If they are allowed to keep their option for more than 90 days following leaving and the shares go up in value following leaving, there will be further tax consequences.

Third, generally where there is no liquidity for the underlying shares, which is typical on an employee only exit, they will need to self-assess any income tax which is due at exercise and pay this through their tax return.

Fourth, you also should be aware that the special relief from capital gains tax (business asset disposal relief) which applies to shares acquired through EMI options is restricted after employees leave.

For the company

Subject to conditions, there should be a UK corporation tax deduction on the exercise of the option for the employer company.

Where the leaver holds their option and exercises at a company exit, any income tax arising at exercise will need to be accounted for and reported through PAYE.  The employer company will also need to account for and report employee national insurance contributions on the taxable amount and pay employer national insurance contributions on the taxable amount, together with apprenticeship levy, where this is applicable.

What about if an employee changes employers or roles within the group?

If your employee is transferred to an overseas company, you might allow them to exercise their options, particularly if there may be adverse tax consequences because of the move.

If your employee is moving to the US, you need to be particularly careful as there can be adverse tax consequences.

If your employee changes roles, the key thing to watch out for is that they continue to meet the EMI working time test.

What next?

Read more frequently asked questions about setting up an EMI scheme, from the qualifying criteria to the registration process, and how it could benefit you in our article: FAQs: setting up an EMI scheme.

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