EMI options – the main issues to think about
This article discusses what type of configuration you want for your option scheme, for example who should get share options, how many each, and when they can actually buy the shares. At a strategic level, the main aim of option schemes is to help companies recruit and then retain their best staff, so getting configuration right is important.
Which employees should get options?
Most of our client companies use EMI schemes to grant options to a handful of key employees, often at director or senior manager level, and perhaps to some of the staff who joined at quite an early stage in the business’s growth. However it is not uncommon to see grants to 20 or more staff.
How many options should be granted?
The usual mechanism is to grant a percentage of share capital to each employee, after the board has agreed to set aside an ‘option pool’ of a certain size, typically between 10% and 20%. This will depend on by how much the existing shareholders are happy to be diluted by the new option shares. You do not have to grant all of the option pool immediately – you could grant a proportion now and reserve the balance for future recruits for example.
There are no set rules for how many or what percentage of options should be granted to each individual. It is entirely up to the board. If you were recruiting a new CEO for a small but high growth tech business you might need to offer 5%, whereas for an MD for a more traditional lower growth manufacturing company you might have to offer 10% to attract the right person. This is because the 5% in a successful tech company will likely be worth considerably more than 10% of the manufacturing company when the businesses are sold.
Some company boards make an assumption about the expected value of the business if it was sold in say 3 to 5 years and then base the number of options on the multiple of salary that the employee should achieve on a sale. For example, if X was on a £75k package, the target was 2 x salary for employees on sale, and the company should fetch £15 million in 3 years, then he would need 1% in options to gain £150k on an exit.
Always remember that you can always grant additional options down the line to a key employee if they are doing exceptionally well – or if you think you weren’t generous enough in the initial grant.
What price should be paid for the shares by the employees?
Companies are free to set the option exercise price, which may be more or less than the market value of the shares on the date the option is granted. The shares over which options are granted must be ordinary shares, although they may be a different class of ordinary share from those held by existing shareholders e.g. they could have no voting rights.
Vesting structure
The basic choice for when the options can be exercised to buy the shares - the ‘vesting’ date - is between some sort of time-based structure (such as vesting on the third anniversary after the options were granted) or an exit-based scheme, where the employee can buy the shares only if the company is sold. There is a separate blog on this and it’s worth reading because it’s a critical area to think about.
Some companies have performance targets for vesting in addition to the normal time or exit based criteria. Such targets can be used in an option scheme, but have to be designed very carefully to avoid disincentivising employees.
Note that each employee would have an individualized option agreement and therefore variables such as the number of options, vesting periods and price etc can be different between option holders, dependent on seniority and other factors – it is up to management and the board to decide on these matters.
Eligibility
Assuming the company and employees are eligible for EMI, setting up a scheme is normally fairly painless - it’s a process that typically takes 5 to 6 weeks.