Most founders have promised equity to someone. Considerably fewer have given it to them.
The conversation usually goes the same way. An early hire takes below market salary on the understanding there is equity attached. It gets confirmed in an offer email, or a Slack message, or across a table. Everyone means it. Nobody does anything about it.
Eighteen months later there is an expectation, a disappointed employee, and no option.
What an EMI option actually requires
A valid EMI option is not a promise written down more formally. It is a specific set of steps, and missing any of them means the option either does not exist or does not get the tax treatment.
- A registered scheme, with scheme rules the company has adopted
- A written option agreement with the individual, setting out the number of shares, the exercise price, when it can be exercised and what happens if they leave
- A market value the exercise price is set against, in practice agreed with HMRC on form VAL231
- A working time declaration from the employee, confirming at least 25 hours a week or 75 per cent of their working time
- Notification to HMRC, and the annual return afterwards
None of this is difficult. It is simply work that nobody does until there is a reason to, and the reason usually arrives at a bad moment.
Diligence, or an exit, or a leaver
An investor asks what is in the option pool and the answer is a number nobody can evidence. Or an acquirer asks and the promises have to be honoured in cash out of the founders' proceeds. Or the employee leaves, believes they are owed two per cent, and there is nothing on either side that says otherwise.
All three of these are expensive. The last one can also be a claim.
What the promise actually is
If you told someone in writing they would receive equity, you may well have created a contractual expectation. That is not nothing. But it is also not an option, and it carries none of the EMI treatment.
Practically, that means the employee has an expectation you may be obliged to satisfy, with no tax advantaged route to satisfying it, and no agreed price. If you later issue shares to make good on it, that is likely to be employment income taxed at their marginal rate, with National Insurance on both sides, on a value they have not received in cash.
The version everyone assumed was happening, where they pay nothing on grant, nothing on exercise, and capital gains on sale, required the paperwork.
The three states people are usually in
No option exists
The most common position. Fixable, and cheapest to fix now. The exercise price will be set against today's value rather than the value when you made the promise, which is the real cost of waiting.
An option, but probably not an EMI one
Something exists and is enforceable. Whether it qualifies for EMI treatment depends on what was done and when. Worth reviewing rather than assuming.
Valid EMI options
What everyone thought they had. The remaining job is the annual return, which is due every year whether or not anything happened.
The cost of waiting
EMI options are granted at a market value agreed at the time. Grant them when the company is worth very little and the exercise price is very low, which is where the value to the employee comes from. Grant them after a funding round at a much higher valuation and the same two per cent is worth substantially less to the person receiving it.
So the delay is not neutral. Every month between the promise and the grant transfers value away from the person you were trying to reward.
If you are in the first position
Work out who you have promised what, and write it down honestly, including the ones you are not sure about. Then set up the scheme properly and grant against it. The conversation with the employee is much easier when you are arriving with a document rather than an explanation.
Promised equity you have not granted?
- You have told hires they have equity but nothing is signed
- You have option agreements but no HMRC valuation
- You are not sure whether your scheme was ever registered
- You have an exit or a round coming and need this cleaned up
It is a short conversation to establish what actually exists, and the answer is nearly always cheaper to act on now than after a round.
Book a call →30 minutes, no charge, no pitch
This article sets out the general position and is not advice on any particular set of facts. Thresholds and rates are those applying at the date of publication.