What are EMI Share Options and are they relevant to business owners looking to sell?

According to the most recently published Government statistics the number of companies setting up Enterprise Management Incentive plans continues to rise whilst other schemes are generally in decline.
Most investors putting money in to or taking over a business look for a solid plan or operation with the right people. What  makes the people ‘right’ can change in the various phases of the development of a businesses life. Can some sort of share scheme help?

Is my shareholding diluted?

Entrepreneurial owners building up their business in anticipation of a sale sometimes discount employee share option arrangement on the basis that any additional shareholders will dilute their own shareholding and reduce their projected sale proceeds. Whilst it’s true that their slice of the cake will be a smaller proportion of the whole, consideration needs to be given to the overall size and whether that reduced slice is actually larger than it would have been.

The wider picture

There are a number of other issues to consider here. Firstly, if because the option arrangements form part of their overall benefits package, the share option holder(s) have been paid a lower salary, then the profits of the business and the cash balances on sale will be more than would otherwise have been the case. Whilst not all business end up being sold on a multiple of profits- and creating a competitive bid situation is Evolution’s specialisation – it’s often the starting point for a valuation. So a very crude comparison just looking at the multiple alone  might be as follows:

table

Its easy to see that the majority shareholders will be slightly better off but there’s a major incentive to the option holder. Remember the option holder has none of their own money at risk – although their salary may be pegged at a lower level. He or she is given the option to acquire shares, normally at market value at the date the option is granted, but only actually exercises the option if the shares have risen in value, often  on the sale of the business. In these circumstances, there’s no tax (or national insurance) for the employee to pay on grant and on exercise the gain is subject to capital gains tax, normally 28% at worst but often 10% if entrepreneurs relief applies. This compares favourably with income tax rates of 40 or 45% (plus NIC).

Earn outs

The existence of these share options can also help solve what can be a practical challenge for  buyers – that of ensuring the key people don’t leave after the sale. The solution is often an earn out, linking the final proceeds to post sale profits but subject to a reduction if they leave. This isn’t possible for employees without shares or options, and  instead the buyer might set up a bonus pool targeted towards these people. But this is often not as effective and can cause disruption with rank and file employees.

Conclusion

EMI share schemes don’t have to cover all employees and are relatively straightforward to establish. Entrepreneurs building up a  business to sell may find then a useful to attract and retainthe people who can deliver growth.

 

Shipleys

 

 

Steve Foster

Principal at Shipleys LLP

FosterS@Shipleys.com

01483 423607

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