In the past few years, there’s been a lot of noise about how we get more tech companies to list in London. But there’s a better way to grow our tech sector: make it easier for entrepreneurs to start and scale transformative businesses in the first place.
For a new government focused on growth, one quick lever can accelerate the growth of UK-based startups and scaleups: better employee equity schemes.
The UK has had a tax-efficient employee equity scheme for a long time: the ‘EMI share scheme’. This enables companies to easily grant share options to employees at no cost to them, and those employees then benefit from 10% capital gains tax on the sale of their shares when the company exits.
This sounds great on paper. But the problem with this scheme is that it encourages fast-growth businesses to stay small and exit early — the exact opposite of what we should be aiming for if we want more homegrown global tech firms.
The EMI scheme doesn’t correlate with scaleup growth timelines and the rules have critical limitations for companies with IPO-level ambition. But there are three easy fixes, which could be quick wins for the new government:
1/ Extend the shelf life of EMI share schemes to at least 15 years
Currently, EMI shares expire after 10 years — yet on average it takes well over a decade from starting a company in Europe, to IPO.
This means if a company doesn’t exit within that 10-year time frame — which the average high-scale company does not — the employees lose their tax-efficient EMI grant, and their shares have to be replaced with much less tax-efficient options.
For businesses with EMIs due to lapse, this can be hugely demotivating for employees — and even more so if it’s looking like the company might exit within the next couple of years, right after employees have lost a big chunk of their financial reward.
It makes no sense to have a scheme in place that discourages a long-term view. By extending the EMI lifecycle to 15 years, businesses can focus on growing at the right pace without fear of employees losing out at the exit.
2/ Allow larger scaleups to offer EMI shares
As it stands, companies cannot issue EMI shares after they exceed 250 employees.
Very few companies IPO at that size. Take Revolut, one of the UK startup scene’s most talked-about potential IPOs, which has over 10,000 on payroll. Or Monzo, which has over 3,000 employees. Both are well past the threshold and showcase the kind of headcount needed to deliver at that scale.
Team size is never a good measure of success. But the reality is, exceeding the 250 employee mark is around when startups hire seasoned talent with enterprise experience that know how to operate with big teams. Why would this talent trade a large, long-established company for a startup without a strong incentive to do so?
With EMI shares currently ruled out for companies with over 250 staff, there are very few good alternative equity options. The last government introduced the ‘CSOP’ scheme as a solution. This allows companies that can no longer offer EMIs to offer CSOP options, which have preferential tax implications for employees on an exit, but has a grant limit of £60k in value, making it not incentivising enough for senior talent. Beyond CSOP, scaleups have to move to ‘unapproved options’ or other variants, where the tax implication for employees on an exit can be very high (50% tax or more).
Nobody wins in practice here — growing businesses and their employees are punished for their success and handicapped along their scaling journey.
Increasing the threshold to 1,000 — or even 500 employees — would give companies the ammunition to attract experienced talent away from established companies at each turn in their journey. And all new joiners would be incentivised to deliver at the highest level to maximise the value of their shares on an exit.
3/ Enable employees to take money off the table along the way
It’s risky to invest 10+ years of a career in a startup, with all the financial reward tied to a single exit event.
One way to smooth the journey for employees is to enable them to sell some of their share options during the scaling journey, for example during major funding rounds.
But in practice, this is very difficult for most larger scaleups with EMI schemes. If the company explicitly writes into their EMI contracts that secondary share sales are permitted, then it can be possible. However most current scaleups — which wrote their EMI contracts 5-10 years ago —do not have this stipulation. When most of these companies set up their EMI schemes, HMRC allowed companies to rely on a blanket ‘board discretion’ clause, allowing the company to approve secondary share sales under EMI rules. HMRC have since tightened its requirements (for reasons unknown), disallowing any company from using board discretion for secondary share sales. If the company allowed an employee to sell shares in this way, all of the tax benefits of the employee’s entire EMI shareholding would fall away entirely.
The government should enable much more flexibility on secondary share sales of EMI options, by making a change in the rules to explicitly allow secondary share sales before an exit for anyone holding EMI options. By making this simple change, employers can better retain talent, reward their hard work with tangible, financial rewards and give them a greater stake in events like major funding rounds.
Employees demand regular recognition and rewards more than ever, and giving startups the ability to deliver on this will only grow in importance. You can only sell people on the long term vision for so long. Everyone has bills to pay and families to support, so enabling financial rewards along an often decades-long journey is a much more incentivising path for everyone involved.
Improving employee equity schemes for startups and scaleups will have an outsized impact in shifting talent from established industries — and other international hubs — into the UK technology sector. If we can do that, we’ll build many more industry-defining UK tech companies as a result.
Read the orginal article: https://sifted.eu/articles/uk-employee-equity-fix/
