Employees can be given a route to participation in the growth in value of the share capital of a start-up company through three basic methods.

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1 launchpad January 2014 emplyee share incentives New cmpanies with ambitins t becme successful high-grwth enterprises need t recruit and retain key individuals t build the business. High quality managerial, financial and technical persnnel are essential. Fr many businesses, building a partnership with all emplyees is critical t lyalty, sustained perfrmance and custmer care. Fr these reasns, share-based incentives can play an imprtant rle in the remuneratin and mtivatin plicies f start-up cmpanies. Types f incentive Emplyees can be given a rute t participatin in the grwth in value f the share capital f a start-up cmpany thrugh three basic methds. Optins: emplyees can be given an ptin t buy shares at sme pint in the future, perhaps dependent n attainment f perfrmance targets, but at a price fixed when the ptin is granted. This is a ne-way bet fr the emplyee because he is nt bliged t invest his wn cash, but if shares rise in value, he can buy shares at an attractive price. Shares: emplyees can be given the pprtunity t buy shares in the cmpany. These might be shares f the same class as funder sharehlders r, pssibly, a special class f emplyee shares. Phantm schemes: these schemes invlve the payment f a cash bnus which is calculated by reference t the value f the shares in the cmpany. Fr a start-up cmpany where share valuatin is difficult and cash ften scarce, a phantm scheme wuld be rare unless dilutin f share wnership must be avided. Naturally, bnus arrangements linked t prfit r turnver (rather than share value) are pssible at any stage in the lifecycle f a cmpany. Issues t watch Several issues need t be addressed when cnsidering what share-based incentives, if any, t make available in a start-up cmpany but fur issues which regularly call fr clse attentin are detailed belw. Cntrl: many funder sharehlders d nt wish shares t be held by ex-emplyees r nn-emplyees. Accrdingly, it is imprtant t include prvisins in the cmpany s articles ensuring that emplyee shares cannt be transferred t nn-emplyees and that departing emplyees must ffer their shares fr sale. In fact, it can ften be simpler t avid having emplyee sharehlders altgether during a cmpany s grwth phase. One cmmn apprach t achieve this result, while prviding an equity incentive, is t grant emplyees exit-nly ptins, that is, ptins which can nly be exercised n a sale r listing f the cmpany. Such an apprach fcuses everybdy s attentin n wrking twards exit, avids the need t set up r implement share buy-back mechanics fr leavers, and means fewer signatures need t be cllected n an investment rund. Marketability: ultimately, ptins r shares have little r n value t an emplyee unless he can sell them fr cash at sme pint. One natural ccasin fr realising the value f ptins r shares is the sale r fltatin f the cmpany. Hwever, if a market fr the shares is needed sner rather than later as part f

2 the remuneratin plicy, special arrangements are necessary. It may be pssible t establish an emplyee benefit trust which can perate, amng ther things, as a buyer and seller f emplyee shares. Tax: tax issues need t be cnsidered carefully bth fr emplyees and fr the cmpany itself. Bradly speaking, share incentive arrangements fall int tw categries: HM Revenue & Custms apprved arrangements, ffering tax benefits but less flexibility, and unapprved arrangements, ffering mre flexibility but at the cst f tax disadvantages. Where capital gains tax treatment applies n a dispsal f shares, a tax rate f 18 per cent will generally apply t basic rate incme tax payers and a rate f 28 per cent t higher and additinal incme tax rate payers. In sme cases, entrepreneurs relief will apply t reduce the capital gains tax rate t 10 per cent n the first 10 millin f qualifying capital gains made by an individual during his lifetime. This relief is available t emplyees/directrs n dispsals f shares in a trading cmpany (r the hlding cmpany f a trading grup) prvided that, thrughut a ne-year qualifying perid, the emplyee/directr wns at least 5 per cent f the rdinary share capital f the cmpany and can exercise at least 5 per cent f the vting rights in the cmpany. In additin, entrepreneurs relief is available t emplyees wh acquire their shares n the exercise f an Enterprise Management Incentives (EMI) ptin prvided certain cnditins are fulfilled including, in particular, that the shares are sld at least ne year after the date f grant f the EMI ptin. Hwever, emplyee-held shares can give rise t incme tax, PAYE and natinal insurance cntributins (NICs) in a range f circumstances (whether n acquisitin, dispsal r therwise). It may be apprpriate within 14 days f the acquisitin f shares by an emplyee fr the emplyee and the emplyer t sign a sectin 431 electin fr the purpses f the restricted securities regime. On a mre psitive nte, cmpanies are generally entitled t a crpratin tax deductin equal t the value f shares awarded t emplyees, whether directly r fllwing the exercise f a share ptin, less any price paid by the emplyees. The emplyee tax cnsequences f an unapprved share ptin granted by the cmpany are as fllws: When the ptin is granted: n tax r NICs arise. When the ptin is exercised: incme tax is payable n any gain calculated as the difference between the market value f the shares at the time f exercise and the price paid fr thse shares by the emplyee. The cmpany may als have a PAYE and NIC liability and needs t ensure that, as regards PAYE and emplyee s NICs, the cmpany will btain full reimbursement f any such tax csts frm the emplyee. Emplyer s NICs (currently charged at 13.8 per cent) can als be (and generally shuld be) made the emplyee s respnsibility. These tax csts can be avided if the cmpany grants enterprise management incentives (EMI) ptins. EMI ptins are tax-privileged ptins specially designed fr use by startup and early stage independent trading cmpanies. Exit: care is needed when designing the terms gverning ptinhlders rights n the sale r fltatin f the cmpany. If a sale ccurs, prvisins shuld be included in the articles t ensure that emplyees are bliged t sell their shares and cannt stall cmpletin. HM Revenue & Custms apprved schemes There are a number f tax-advantaged emplyee share schemes namely: Enterprise management incentives (EMI) under which emplyees in independent trading cmpanies with

3 fewer than 250 emplyees and grss assets nt exceeding 30 millin can each be given tax advantaged ptins ver shares wrth up t 250,000 at the time f grant. The tax privileges f EMI ptins are very substantial and the legislatin prvides cnsiderable flexibility fr a cmpany t design tailr-made ptins t fit the specific business situatin. EMI ptins are explained in mre detail in the next sectin and further infrmatin is available at the HM Revenue & Custms website at A cmpany share ptin scheme (CSOP): ptins are awarded t emplyees selected at the discretin f the directrs f the cmpany. Prvided the scheme maintains apprved status, ptin exercise is tax-free if exercise ccurs at least three years after grant r in gd leaver circumstances. The share incentive plan (SIP), which was riginally knwn as the new all-emplyee share wnership plan, has been described by the HM Revenue & Custms as the mst tax-advantaged all-emplyee share plan ever intrduced in the UK. Emplyees may, fr example, purchase up t 1,500 f partnership shares each year; alternatively a cmpany may award up t 3,000 p.a. f free shares subject, if apprpriate, t reaching agreed perfrmance targets. A savings-related share ptin scheme (Sharesave): ptins are ffered t all emplyees f the cmpany wh must enter int a savings cntract with an apprved institutin. In practice, this scheme is nt suitable fr start-up cmpanies. Nrmally, early stage cmpanies have fund the qualifying cnditins fr SIPs, Sharesave schemes and even CSOPs t cumbersme t be practical. Hwever, changes made by the Finance Act 2013 have made CSOPs mre flexible and take up may increase amng cmpanies which cannt, fr sme reasn, grant EMI ptins. Since September 2013, it has been pssible fr cmpanies t invite emplyees t becme emplyee sharehlders by giving up certain statutry emplyment rights in exchange fr receiving at least 2,000 wrth f shares. Fr the emplyee, the tax benefits are that, first, the first 2,000 wrth f shares are tax-free n receipt and, secndly, any shares s received (up t a maximum value n receipt f 50,000) are exempt frm capital gains tax n sale. Hwever, the general cnsensus, is that the emplyee sharehlder scheme is, fr varius technical and practical reasns, t cmplex t be suitable fr mst early stage cmpanies. Unapprved share incentives Unapprved arrangements can take literally any frm. It may be impssible t grant EMI ptins, fr example, because the cmpany is treated as being under the cntrl f its principal crprate investr(s) r the prpsed ptinhlder is a nn-executive directr. In these circumstances, unapprved ptins can be granted but the effective rate f tax n exercise fr the ptinhlder may be ver 50 per cent (if he r she is made respnsible fr emplyer s NICs). Fr this reasn, r ut f a preference fr prviding emplyees with equity nw, shares rather than share ptins might be apprpriate. If s, unapprved emplyee share schemes permit maximum flexibility when designing the rights and restrictins attached t the shares. But advice shuld be taken t avid r minimise the impact f rules which culd impse incme tax, PAYE and NICs n future grwth in the value f the shares. Using an emplyee benefit trust An emplyee benefit trust (EBT) is a vehicle thrugh which shares may be held by trustees fr the benefit f emplyees. The trustees may be individuals but, mre typically, a subsidiary cmpany will perfrm this functin. An EBT, funded by the cmpany r pssibly with external finance, can subscribe fr shares r buy shares frm selling sharehlders. Thereafter the EBT can sell shares, r award ptins, r transfer shares free f charge t emplyees. An EBT can serve as a warehuse fr shares intended t be made available t emplyees at a future date, r perate effectively as an internal market fr shares. In sme circumstances an EBT s rle f prviding

incentives and rewards t emplyees t assist the trading perfrmance f the cmpany will result in increased wnership f shares by the next generatin f managers, and, incidentally, facilitate lng-term

Thus, an EBT has wide-ranging ptential t assist with emplyee share wnership arrangements but, whatever yur cmmercial strategy, advice n a range f legal and tax issues shuld always be taken in rder t

4 incentives and rewards t emplyees t assist the trading perfrmance f the cmpany will result in increased wnership f shares by the next generatin f managers, and, incidentally, facilitate lng-term successin planning. Thus, an EBT has wide-ranging ptential t assist with emplyee share wnership arrangements but, whatever yur cmmercial strategy, advice n a range f legal and tax issues shuld always be taken in rder t avid pitfalls fr the unwary. Cntact If yu wuld like t discuss yur business venture with a member f ur LaunchPAD team please cntact: Manchester Debrah Clark Head f Private Tax & Trusts T +44(0) E debrah.clark@mills-reeve.cm Cambridge Christpher Twnsend Partner T +44(0) E christpher.twnsend@mills-reeve.cm Cntact details fr each specialist member f the LaunchPAD team can be fund at the end f the respective chapters. LaunchPAD is als available nline at Mills & Reeve LLP is a limited liability partnership authrised and regulated by the Slicitrs Regulatin Authrity and registered in England and Wales with registered number OC Its registered ffice is at Funtain Huse, 130 Fenchurch Street, Lndn, EC3M 5DJ, which is the Lndn ffice f Mills & Reeve LLP. A list f members may be inspected at any f the LLP's ffices. The term "partner" is used t refer t a member f Mills & Reeve LLP. The cntents f this dcument are cpyright Mills & Reeve LLP. All rights reserved. This dcument cntains general advice and cmments nly and therefre specific legal advice shuld be taken befre reliance is placed upn it in any particular circumstances. Where hyperlinks are prvided t third party websites, Mills & Reeve LLP is nt respnsible fr the cntent f such sites.

launchpad enterprise management incentives January 2014 Enterprise management incentives (EMI): General requirements Qualifying companies

launchpad enterprise management incentives January 2014 Enterprise management incentives (EMI): General requirements Qualifying companies launchpad January 2014 enterprise management incentives Enterprise management incentives (EMI) ptins are tax-privileged share ptins available t small and mediumsized trading cmpanies. Share ptins are an