13 Nov
2023

How to design an EMI share option scheme

One of the advantages of EMI is that the design of a scheme is very flexible. You can use a variety of vesting and exercise structures, and use different share classes to confer varying rights to voting, dividends and exit proceeds.

In simple terms, there are two main forms of vesting and exercise:

1. vesting and exercise only on a sale of the company - an 'exit' event

2. vesting and exercise on a time basis

There are three core terms for option schemes:

Grant’ means the award of the EMI share options to an employee, subject to the stated vesting and exercise conditions

Vest’ means when option rights are conclusively ‘earned’ by the employee and that those options can be exercised

Exercise’ - the date from which the employee can actually buy the shares

Exit only vesting and exercise 1

Options

15% of shares between five key staff

Vesting

On the date of an exit event (i.e. the sale of the company, which could include a management buy out or flotation)

Exercise

Exercise permitted on the date of an exit event

Exercise price

Set at the market value agreed by us with HMRC

Leaver policy

Options lapse automatically on leaving

Notes

This type of vesting structure is probably the most straightforward scheme design. Easy to understand and popular with clients because it focuses everyone on building value towards a sale and also avoids any admin hassles and other issues caused by having employee shareholders prior to an exit

Exit only vesting and exercise 2

Options

5% of shares between five staff

Vesting

The options vest over four years, with 25% vesting on the first anniversary of the grant date and then the balance on an equal monthly basis over the next three years.

Exercise

Exercise permitted on the date of an exit event, or by a good leaver within 90 days of departure

Exercise price

Set at the market value agreed by us with HMRC

Leaver policy

If an employee leaves within 12 months of joining then they lose all of their options (this is known as the 'one year cliff') but after that they can exercise their vested options on leaving, if they are a 'good leaver' which is defined as leaving for any reason other than misconduct, fraud or joining a competitor

Exit only vesting and exercise 3

Options

20% of shares between three senior staff

Vesting

Exercise permitted on the date of an exit event. The option holders were granted options over a new class of shares which on exit provides for the company founder to receive the first £2 million of the sale proceeds, with the option holders then receiving their proportionate share in excess of £2 million. In this way, the founder reserved for himself some of the value he had built in the company.

Exercise

Exercise permitted on the date of an exit event

Exercise price

Set at the market value agreed by us with HMRC

Leaver policy

Options lapse automatically on leaving

Exit only vesting and exercise 4

Options

Fifteen employees at a software company were granted options of between 0.5% and 3% of the shares each, depending on seniority and length of service

Vesting

Options vest on an exit event

Exercise

Exercise permitted on the date of an exit event

Exercise price

The exercise price was set at £0.01 per share, whereas the market value agreed with HMRC was 50p per share. This is permitted, but means that on an exit, when the shares are sold to the acquirer, the option holders will have to pay income tax on the first 49p of any gain per share, because the discount from the agreed market value is a taxable benefit. Then any gain over 50p per share is subject to capital gains tax at only 10%.

Leaver policy

Options lapse automatically on leaving

Time-based vesting and exercise 1

Options

10% of shares between two senior execs.

Vesting

Vest over the two years following the grant, with half of the options each vesting on the first and second anniversaries of the date of the grant

Exercise

Exercise permitted when the options vest

Exercise price

Set at the market value agreed by us with HMRC

Leaver policy

Board discretion (the directors decide whether a leaver may retain any options)

Time-based vesting and exercise 2

Options

5% of shares to a new CEO

Vesting

Vested six months after the date of grant

Exercise

Exercise permitted when the options vest

Exercise price

Set at the market value agreed by us with HMRC

Leaver policy

Good leavers may exercise on departure. A good leaver in this case was defined as someone who leaves due to physical or mental incapacity, or on death in service.

Time-based vesting and exercise 3

Options

Three employees granted 3% each

Vesting

Vest over the three years following the grant, with one third of the options each vesting on the first, second and third anniversaries of the date of the grant, if performance conditions are achieved each year

Exercise

Exercise permitted when the options vest

Exercise price

Set at the market value agreed by us with HMRC

Leaver policy

Board discretion (the directors decide whether a leaver may retain any options)

Notes

The options will vest each year only if the company achieves certain revenue and gross profit targets in the prior financial years

Go to EMI introduction