Shares only incur Capital Gains Tax, so long as they are issued for a price that reflects their current value.
Employee share schemes: everything you need to know
Share schemes are a superb, cost-effective way of motivating your team and are increasingly being launched by progressive companies of all shapes and sizes.
We created the Vestd to make it easy for company founders and directors to set up and manage share schemes, and have plenty of insight to share. We thought we’d write this easy-to-read guide to help you if you’re going down this path.
We’ll answer some of the most common questions such as how much a scheme will cost, and how to distribute shares in a tax-efficient way.
We'll explain the difference between shares and options, and help you understand how to protect the business.
Right then, where to start? At the very beginning, of course.
What is an employee share scheme?
An employee share scheme is a way of sharing company ownership with your team. You can reward one or more key people with equity, or all of your employees. That’s entirely up to you.
You can also distribute shares to non-employees, such as consultants and advisors, though it is sometimes best to run different types of schemes for internal and external people.
Choosing who to give equity to is just the start. Figuring out the right type of scheme for your particular needs is where things get a little bit more complicated. There are at least ten ways of distributing equity, and each one has various pros and cons.
But let’s back up for a minute. Before we dive into the detail, why on earth would you want to give anybody shares in your business?
Why launch an employee share scheme?
Philosophically you may be the kind of founder or company director who wants to give the team a slice of the action. If that’s the case, we salute you.
Then again, you – or your board – might not be so sure. Dilution is par for the course when you start to reward the wider team with equity, so existing shareholders will need to be convinced that reducing their overall stake will pay off in the long run. And that’s totally understandable.
Thankfully there is a lot of research that you can use to underpin a business case for your share scheme. In pure value terms, sharing ownership makes sense, and there are lots of softer benefits too.
Six reasons why you should launch a share scheme
Attract the best talent 🧲
Hiring is tough and it is never a level playing field. Offering equity to new employees is one way of bringing top talent into the business.
You can also level the playing field by offsetting salary for equity, allowing you to put together a compensation package for people that matches or improves on offers made by other more established companies with deeper pockets.
Retain the best talent ❤️
Sharing ownership makes people feel differently about the business. They are less likely to leave something that they own a piece of. Employee loyalty is a big issue for many firms. The average cost to replace a leaver is around £19k.
That’s a huge burden on businesses of all sizes, but especially those in the early or growth phase. Share schemes are proven to increase employee retention and can help you avoid hiring costs.
Increase productivity and performance ⚙️
Studies have shown that employees who are also shareholders work harder because they feel directly responsible for the value of their company. This motivates them to do their best work and they also take more responsibility for the performance of their co-workers.
More productive employees mean not just a better work culture and less turnover but also higher output, increased revenue for the business, and decreased costs related to finding talent and keeping them.
Improve employee engagement and happiness 💡
The more all employees feel included in the mission, direction, and success of the business, the more they’re motivated to contribute to the company. And they are more likely to stick around. All of which is vitally important to a healthy company culture.
Relieve cashflow pressure 💸
Equity is often used to raise finance, but there is a flipside that the savvier founders and CFOs/FDs understand: equity can also be used to reduce the need for finance. Instead of depleting cash resources to pay people top rates and large bonuses, why not incentivise them via shares or options?
If done correctly the tax advantages are much more attractive than giving people an annual salary bump, or bonus. And that means you can preserve your bank balance.
Increase overall business value 🚀
The result of all of these benefits is a stronger, happier team that works harder and which is more emotionally committed to the business. And that’s likely to add up to a heap of additional business value.
Shout about these benefits if any of your investors or board wants to know why you’re planning on launching a scheme.
If you want an independent voice to help you, then get in touch and we will help you to make the business case. Here's one we made earlier...
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:
- Would you like to give people shares right away, or would you like them to buy them at some point in the future?
- Do you want to give shares to employees, or non-employees, or both?
- Do you need performance milestones to be reached before releasing the equity?
- What do you want to happen if people leave the business?
- 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, let’s quickly outline 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.
There are two types that we will now focus on and explain.
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.
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.
Share options allow recipients to buy shares at a later date, at a pre-approved price. 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.
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 a lower rate of just 10% 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:
- On award (only affects ordinary shares)
On exercise (only affects options)
- 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:
Capital Gains Tax (CGT)
Normally between 10–20% 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.
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 ten 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
Company Share Option Plans (CSOPs)
Share Incentive Plans (SIPs)
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 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 CSOPs, 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:
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.
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.
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.
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.
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.
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.
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™ 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
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.
If you’re looking to reward non-employees with equity then one of the other schemes will be a better fit.
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.
It is worth noting that you can have multiple schemes running in conjunction, in the event that you want 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 four of the more popular schemes...
How much does it cost to launch a share scheme?
This is another question we hear every day. It is actually the wrong question to ask, as you should consider the costs over the long run. The initial launch costs are usually multiplied over the lifetime of a scheme.
So how much does it cost to set one up?
As ever it depends but the traditional way of setting up a scheme would be to ask your accountant or lawyer for help. And typically that would cost upwards of £5k for a small scheme.
We’ve also heard of some downright astonishing quotes. Some of the bigger practices think nothing of quoting £10k for a one-person EMI. Another example was a quote of “£25k–£30k” for a handful of EMIs. And that’s just for setup... there will be extra costs for managing and amending schemes. Big bucks.
Why is it important to figure out the long-term cost?
Surely you want to know what you'll need to stump up over the next few years? Most schemes last for four or more years, and since accountants and lawyers are time-based businesses, every time you need something done they’re likely to charge for it.
Managing a scheme means adding and removing people. It means submitting various forms to HMRC. It means figuring out new company valuations as your business grows. All of these things usually incur fees from accountants and lawyers.
That’s totally reasonable of course, but it’s important to ask the question about charges upfront so you can budget accordingly.
How much does Vestd charge?
We launched Vestd to provide an easy way of launching and managing share schemes. We wanted to make it predictably affordable, so our prices start from £160 a month.
Our platform is software as a service, but we also provide expert support from start to finish. The level of guidance you need – as well as the number of scheme members and a few other variables – will determine which monthly package you’ll need.
As such our pricing model is transparent, predictable, and all-inclusive. There are no ad hoc fees along the way. We don’t charge a fee for setting up new schemes, but we do charge a small migration fee when we’re asked to digitise an existing scheme.
Vestd is the modern way to create and manage tax-efficient employee share schemes.
It is the only digital equity management platform with full, two-way Companies House integration, which means you can avoid a ton of paperwork. No forms, no stamps, no post boxes. Everything is done digitally.
We hope this guide to share and share option schemes has proved helpful. For some specific guidance, you can book a call with one of our equity specialists to find the right answers for your business.
Let's discuss tax-efficient shares & options!
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