Top 10 EMI Errors To Avoid

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Orrick, Herrington & Sutcliffe LLP

EMI options are a form of option which benefit from very generous tax reliefs. The conditions relating to the company, the optionholder and the option agreement are quite complex. Technical errors are, unfortunately, relatively common, and often only discovered on a due diligence process as part of a funding round or exit. While certainly not exhaustive, this guide explains the most common errors we see made by companies with EMI schemes. Its purpose is to enable companies to identify any issues before they arise in a transactional context and to deal with them at the earliest possible stage.

  1. The optionholder not signing a working time declaration. It is a key requirement of the EMI legislation that the optionholder must sign a declaration stating that they comply with the working time requirements. The declaration can be included as part of the option agreement. Declarations cannot be backdated.
  2. Not executing the option agreement as a deed. The option agreement must give the optionholder a right to acquire the shares. The simplest way to do this is to execute the option agreement as a deed.
  3. The company not being independent of other companies. The company over whose shares the EMI options are granted must be independent of other companies. Not only does this mean it can't be a 51% (or more) subsidiary of another company, but it also excludes companies which are under the control of another company more generally. There are also complex tests which can be an issue if a founder is connected to a corporate shareholder. There must be no arrangements in existence by which the company would cease to be independent.
  4. The company having subsidiaries which are not qualifying subsidiaries. Any subsidiary the company controls must be a 51% subsidiary and no other person may have control of the subsidiary (nor can there be any arrangements in place for another person to take control).
  5. No agreed value of the shares. If the value of the shares is not agreed with HMRC prior to granting the options, the amount of tax which may arise on the exercise of the options (if any) cannot be calculated with certainty. This can be a real issue on an exit.
  6. Not granting the options before the valuation expires. When HMRC agree to a valuation of the shares, they will set an expiry date for the agreed valuation. The company should grant any options which rely on the valuation during the period for which the valuation is valid.
  7. Not notifying HMRC of an option grant. The company must notify HMRC once an option has been granted within 92 days of the date of grant. Forgetting to notify HMRC within this period will likely mean that the option granted is not a valid EMI option.
  8. Changing the terms of an EMI option. If a change is made to the terms of the EMI option, this may be treated by HMRC as the grant of a new option, with the potential for negative tax consequences for both the company and the optionholder.
  9. The company not keeping track of its compliance with the EMI limits. Accidentally exceeding the EMI limits will mean that options granted in excess of the limits (which are calculated by reference to the unrestricted market value of the shares) will not qualify for EMI treatment. The company needs to keep track of these limits (and bear in mind that if CSOP options are also granted, they must be taken into account and that the grant of a CSOP option which causes the EMI individual limit to be exceeded can be a disqualifying event in relation to the relevant EMI option). The limits are currently £250,000 for the individual and £3,000,000 for the company.
  10. Not including a summary of the restrictions on the shares. There should be a brief list of any restrictions on the shares, detailing where they can be found (for example, in the company's articles of association, which should be enclosed with the option agreement).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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