Employee share schemes: what you need to know

How do employee share schemes work?

Share schemes come in various shapes and sizes. Each one works slightly differently, and most can be customised to suit your specific needs. Before designing your scheme you should figure out your own motivations for giving people equity.

Ask yourself the following questions:

1. Would you like to give people shares right away, or would you like them to buy them at some point in the future?
2. Do you want to give shares to employees, or non-employees, or both?
3. Do you need performance milestones to be reached before releasing the equity?
4. What do you want to happen if people leave the business?
5. How big is your business, both in terms of team size and asset value?

Answering these questions will help get to the heart of what you are trying to accomplish by launching a scheme, as well as some basics about your business.

Your company may not be eligible for all scheme types, so that’s one way of quickly whittling down your possible choices.

In addition, certain schemes are specifically designed for employees, as opposed to consultants and advisors. So if you are looking to incentivise third parties then some schemes won’t apply.

There are two distinct ways of sharing ownership: shares and options. And there are a number of scheme types for each one.

So before we investigate the scheme types, we need to start with the differences between shares and options, and why you might choose one over the other.

What's the difference between shares and options?

You can give people ​actual shares​ now, or choose to issue ​share options​ that can be exercised at some point in the future (becoming shares either then, or at the time of an exit event).

Shares and options have different uses, and benefits, including the tax position. 

Real shares

There are two types:

1. Ordinary shares are real shares in the business (rather than an option to buy at a later date) and can be given to anyone. They are typically the shares business owners and investors will hold.

2. Growth shares are just like ordinary shares but are issued at a ‘hurdle price’ that represents a small premium to the value of the company at that time (often around 10%-40% to reflect the "hope value" of the shares). As such, the recipient only shares in the business' growth in value from that point on.

Growth shares can also be conditional, which means the recipient must meet conditions in order for their shares to vest, and become unconditional. Though this is only possible if your Articles of Association allow it.

Key takeaways

• Shares only incur Capital Gains Tax, so long as they are issued for a price that reflects their current value.
• Shares are issued in the recipient's name.
• Recipients can receive voting rights.
• Shares give people real ownership immediately.
• Recipients can benefit from dividends.
• Growth shares can be conditional.

Options

Share options allow recipients to buy shares at a later date, at a pre-approved price. By the way, option schemes are sometimes called Employee Stock Ownership Plans (ESOPs).

If you want to set up an incredibly tax-efficient share scheme for employees (as opposed to non-employees), then in almost all cases an EMI option scheme is the best way to go. Your company will need to meet some qualifying criteria to be able to benefit.

Key takeaways

• Options can be granted to anyone.
• Options are not real shares until exercised.
• Options may incur a tax liability on exercise.
• Recipients do not get any benefits of being a shareholder (e.g. dividends, or voting rights) until they exercise their options.
• In some cases, there is also a cost to exercise, which some employees may struggle to afford. 

Are company share schemes tax-free?

We hear this question pretty much every day. Naturally, company founders and directors will want to keep costs to a minimum, so let’s quickly answer it before looking at the different types of share schemes.

For employees and other shareholders, the short answer is always a firm ‘no’.

In the UK shareholders are always subject to Capital Gains Tax. So there will be something to pay on any gains. However, you can avoid paying the top rate of CGT.

EMI schemes are particularly tax-friendly for recipients, who benefit from paying a lower rate on any gains over and above the value agreed with HMRC when the shares are sold (so long as the sale is at least 24 months after the grant of options).

This is why share schemes make for brilliant incentives. Compare that to the standard amount of tax they would incur on an annual bonus (especially for the top earners on a higher tax rate).

EMI schemes are also amazingly cost-effective for employers, as there are a number of offsets from the scheme against their own Corporation Tax liability.

Other scheme types don’t come close to this tax position, and have different tax implications, but can be useful in different ways, depending on what you’re trying to do.

So, to be absolutely clear, in the UK there are three points at which tax can be due for recipients:

1. On award (only affects ordinary shares)

2. On exercise (only affects options)

3. On sale (always due on all shares)

Then there are two different types of tax that generally apply, with an extra bonus for qualifying entrepreneurs:

1. Capital Gains Tax (CGT)
2. Income Tax

Normally between 18–24% CGT is due on the sale of the shares and applied to the gain in the value of your shares from the point they were given. Or in the case of options, on any gain in value over the price paid on exercise.

If you qualify for Business Asset Disposal Relief (formerly Entrepreneur's Relief) you'll currently pay 10% CGT. Rates are set to rise to 14% in the 2025/26 tax year and 18% in 2026/27, but that's still less than the standard CGT rate.

As for Income Tax, that's typically between 20–45% (based on the recipient’s current tax rate) and is due at the point that the option is exercised, or in some cases, on sale.

What are the different types of share schemes?

We have identified 10 different ways of distributing equity.

Some of these methods are aimed at huge companies where everybody owns a small slice of the pie. Others are better suited to companies in the startup phase, where there are a handful of founders.

We’ve also mentioned that some schemes are ‘approved’, which means getting the nod from HMRC in advance. Other schemes are unapproved and tend to be less tax-efficient, but can be much quicker to set up, and in some cases are going to be a better path to take.

Finding the right fit depends on the shape of your business, and what you are looking to accomplish from setting up a scheme.

The four HMRC-approved share schemes

1. Enterprise Management Incentives (EMIs)

2. Company Share Option Plans (CSOPs)

3. Share Incentive Plans (SIPs)

4. Save As You Earn (SAYE)

As we've mentioned, EMI option schemes are particularly interesting and very popular among startups, scaleups and established SMEs. They offer wonderful tax advantages for both employer and employee.

We’re pretty sure that Vestd sets up more of these schemes than any other provider in the UK, and we've made it really easy to launch an EMI scheme or digitise a CSOP on our platform.

Unlike EMI and CSOP schemes, SIP and SAYE schemes need to be company-wide, with all employees eligible to participate. They are normally used by bigger companies with many hundreds or thousands of employees.

Vestd doesn’t currently offer SIPs or SAYE schemes, so please check out the government site for more detail on each of these scheme types.

The six other methods

Non-approved schemes can offer a lot of flexibility, but there are fewer benefits when it comes to paying tax on any gains. You don’t need to bother HMRC in advance so they can be very quick to set up.

Here are six unapproved ways of giving people shares:

1. Ordinary shares

   Ordinary shares provide people with a real share in the business right now, rather than an option to buy at a later date. They can be given to anyone and are typically the shares business founders and investors will hold.
   
   At their simplest, ordinary shares give the holder of each share the same rights to dividends, capital and voting in the company. Most companies are founded with – and issue only – ordinary shares.

2. Preferred shares

   Often known as ‘prefs’, these shares typically give their holders rights to specific dividends ahead of all ordinary shareholders and also give them rights to a specific amount of the capital at a winding up of the company ahead of any ordinary shareholders. Investors often demand preferred shares.

3. Growth shares

   Great for founders who are looking to bring people into the business after it has built up some initial value. Growth shares are just like ordinary shares (and take immediate effect) but are issued at a ‘hurdle price’ that represents the value of the company at that point in time plus a small premium (usually 10%-40%).

   As such, the recipient only shares in the business' growth in value from then onwards, as opposed to the legacy value. Conditions can be applied to growth shares, to protect the business.

4. Unapproved options

   Super flexible, unapproved options can be used to incentivise the wider team, including non-employees such as contractors, advisors or consultants. They are not as tax-efficient as EMI schemes, but don’t require HMRC valuation approval so can be quicker to set up.

5. Restricted Stock Units (RSUs)

   RSUs are another way of issuing equity. They can be structured rather like options, but shareholders are taxed when the shares vest. Like other options schemes, RSUs can be conditional and subject to a vesting schedule.

6. Employee-owned trusts (EOTs)

   EOTs own controlling stakes in businesses on behalf of employees. They were introduced in 2014 as an incentive for owners to sell, as part of the government’s desire to increase the number of employee-owned businesses in the UK.

   There are various tax benefits for shareholders, including a CGT exemption, and bonuses of up to £3,600 a year can be offered tax-free.

Learn more about the different kinds of employee ownership.

Which share scheme is right for me?

This is going to depend on various factors, but let's start by exploring a flexible framework that will allow you to reward different people in different ways while protecting existing shareholders...

Agile Partnerships™

Agile Partnerships™ were devised by Vestd to provide founders with maximum flexibility, from the inception of the business right through to exit.

An agile framework can include multiple types of share schemes (e.g. EMI + growth shares), so employees and non-employees can participate. This approach helps startup founders share ownership with key people in a way that is fair, and which protects the business (and all shareholders).

Your Agile Partnership™ will be based on a pre-agreed set of deliverables. Everybody will be clear on what they need to bring to the party. If someone delivers 100% of what they said they’d contribute, then 100% of the agreed equity will be released.

If they don’t then they get a proportion of what was agreed. You set the conditions and everyone knows what is expected of them.

The beauty of Agile Partnerships™ is that they can be launched at any stage of a company's journey.

They are ideal if your company is in its infancy and you want to get agreements in place with your co-founders and early hires. They can also be used to remotivate an existing team or to help shareholders transition out of a business on good terms.

We believe that Agile Partnerships™ are the future of equity-based agreements, so do get in touch if you'd like to explore setting one up.  

Enterprise Management Incentives

Let’s cut to the chase: if you run a small business then start by reading up on EMI schemes. More often EMI is the right choice if:

• You want to give equity to employees (rather than external folk)
• You meet the EMI eligibility requirements
• You want to set some conditions

EMI is the most tax-efficient share scheme in the UK. And the most popular by far.

These schemes are normally a very good fit for startups, scaleups, and established limited companies in the UK. You can quickly set up an EMI scheme via Vestd, or learn more about these fantastic schemes by downloading our free EMI guide.

Company Share Option Plans

Also tax-friendly, CSOPs are a great alternative to the EMI scheme if a company isn't eligible. CSOPs are stretchier with no limitations on company size and fewer requirements.

CSOPs are the next best thing after EMIs.

A company can outgrow EMI, which is only eligible for businesses with fewer than 250 employees. It's entirely possible to have both an EMI scheme and a CSOP set up to counter this.

That said, there are a couple of things to be aware of when it comes to CSOPs, like the three-year rule. But if you're interested, we dive into loads more detail in our free CSOP Essentials guide.

Now, if you’re looking to reward non-employees with equity then growth shares or unapproved options may be more suitable.

Growth shares

If your company is more established and hiring senior people to accelerate performance then growth shares are a good fit.

Growth shares reward newcomers for helping to create future value, as opposed to the value you have already built up in your business.

Growth shares are great for fast-growing businesses with a solid exit plan.

And, as we mentioned earlier, growth shares can be conditional too. Read our free Beginner's Guide to Growth Shares to learn more.

Unapproved share options

Don't be put off by the name. There's nothing nefarious about unapproved options. All it means is that they don't have the same superb tax benefits that HMRC-approved schemes do. But they are incredibly flexible!

Unapproved options are the most flexible.

Virtually any business can use unapproved options to incentivise and reward talent (in-house or external) quickly. And unapproved option schemes can be conditional, so in that sense, they're a safer bet to ordinary shares.

You can have multiple schemes running in conjunction to incentivise different people in different ways.

An overview of the main scheme types

To quickly compare the different schemes take a look at this comparison table. It provides you with an at-a-glance overview of the pros and cons of the more popular schemes. (Click to enlarge).