Why cash-strapped startups give away shares
When you're an early-stage company, you're competing for talent against businesses that can pay 30% more in salary. You can't win that fight with cash. What you can offer is a slice of the upside: if the company is worth a fortune one day, the people who built it share in it. That's the whole idea behind share options, and EMI (Enterprise Management Incentives) is the government-backed scheme that makes it tax-efficient enough to be worth doing.
EMI is the UK's most generous employee share scheme, designed specifically for smaller, growing companies. Done right, an employee pays no income tax when the option is granted, no tax when they exercise it, and only Capital Gains Tax, often at a reduced rate, when they finally sell. Done wrong, or not reported to HMRC in time, and the whole tax advantage can evaporate. Here's exactly how it works.
What an EMI share option actually is
An option isn't a share. It's the right to buy a share later, at a price you fix today. Say you grant an employee an option over 1,000 shares at £1 each (the "exercise price"). They don't own anything yet and they haven't paid anything. If the company grows and those shares are worth £50 each when they sell, they exercise their option, buy at £1, and pocket the difference. If the company goes nowhere, they simply never exercise, and they've lost nothing.
This matters for two reasons. First, employees aren't out of pocket up front. Second, because it's an EMI option rather than a plain gift of shares, HMRC gives it special tax treatment, provided you follow the rules.
Does your company qualify?
EMI is aimed at genuine trading startups, not every business. To grant EMI options your company must broadly be:
- An independent trading company (not more than 50% controlled by another company)
- Have fewer than 250 full-time-equivalent employees
- Have gross assets of £30m or less
- Carry on a qualifying trade (most trades qualify, but some are excluded, such as banking, property development, farming and legal or accountancy services)
There are also limits on the options themselves: up to £250,000 of options per employee (measured by the value of the shares at grant), and a total of £3m of options across the whole company.
Excluded trades catch people out. If you're a property, finance or professional-services business, check carefully before you promise anyone EMI. The rules exclude a surprising number of trades, and finding out after you've granted options is a painful conversation. If you're not sure,
get started with us and we'll sanity-check it before anything is signed.
Do your employees qualify?
EMI is for employees, not consultants or non-executive advisers. To hold EMI options a person must:
- Work for the company (or a qualifying subsidiary) for at least 25 hours a week, or if less, at least 75% of their total working time
- Not hold more than 30% of the company's shares already
That 25-hours-or-75% test is why EMI works for full-time hires and founders' early team, but not for the freelance developer who does two days a week elsewhere.
The tax treatment, in plain English
This is where EMI earns its keep. Compare an ordinary bonus with an EMI option on the same value of upside:
- At grant: no income tax and no National Insurance, as long as the exercise price is set at (or above) the market value of the shares at that date.
- At exercise: normally no income tax either, again provided the exercise price was set at market value at grant.
- On sale: the gain is taxed as a capital gain, not income. It's often eligible for Business Asset Disposal Relief (BADR), which taxes the gain at a reduced Capital Gains Tax rate. The BADR rate has been rising, so check the current rate before you rely on a figure.
Contrast that with a cash bonus, which is hit with income tax at 20%, 40% or 45% plus National Insurance. For a higher-rate employee, the difference between a capital gain and a taxable bonus can be enormous.
Worked example. An employee is granted options over shares worth £10,000 at grant, with a £10,000 exercise price. Three years later the company sells and their shares are worth £110,000. They exercise (paying £10,000) and sell. Their £100,000 gain is a capital gain. If it qualifies for BADR, it's taxed at the reduced CGT rate rather than as £100,000 of salary taxed at 40% plus NI. Same reward, a fraction of the tax. (Rates change, so check the current CGT and BADR rates.)
The paperwork you must not skip
EMI's tax breaks are conditional on getting the admin right. Two things trip startups up most:
- Agreeing a market value with HMRC. You can ask HMRC to agree the market value of your shares before you grant (a valuation agreement). This locks in the exercise price and removes the risk of an income-tax charge later. It's not compulsory, but it's strongly advised.
- Reporting the grant to HMRC in time. Every EMI option grant must be notified to HMRC through the online Employment Related Securities service within 92 days of the grant date. Miss that window and the options can lose their EMI status, and with it the tax advantage. You also file an annual ERS return each year while the scheme is live.
You'll also need a properly drafted option agreement for each employee, setting out the exercise price, the number of shares, and the "vesting" conditions, for example, options vesting over four years so people have to stick around to earn them.
Why funded startups lean on EMI
If you've raised money, or you're about to, EMI does three jobs at once. It lets you hire senior people you couldn't afford on salary alone. It aligns the team with the outcome investors care about, a good exit. And because options only pay out if the company succeeds, it costs you nothing in cash today. That combination is why an EMI option pool is close to standard in venture-backed UK startups, and why investors often expect to see one.
If you're weighing up how to structure pay and equity as you grow, it's worth reading our guides on SEIS and EIS for investors and hiring your first employee alongside this one, since the three decisions tend to land at the same time.
The bottom line
EMI is one of the genuinely good deals in the UK tax system for startups, but it's unforgiving on detail. The qualifying tests, the valuation, and above all the 92-day reporting deadline are where the value is won or lost. Get the setup right once and you have a powerful, low-cash way to build a team. Get started and we'll help you put a scheme in place that actually stands up.
