2 April 2019
I’m currently working on a company sale where the vendors are looking to negotiate terms such that the deal rewards certain key, and long-serving, employees in order to recognise their hard work and loyalty over the years which has helped the vendors get to the brink of a successful exit.
Whilst these terms are undoubtedly negotiable with the buyer, there is not very much we can do in terms of making the rewards tax efficient in the hands of the employees, and a straightforward taxable bonus looks to be the only practical solution. So, whilst the vendors are able to enjoy a 10% tax rate on the gain they will make on the disposal thanks to Entrepreneurs’ Relief (ER), the employees are likely to be handing >40% over to HMRC in the shape of PAYE and Employees NI. As the employer, the company will also be facing a NI charge on the value paid to the employees which will no doubt be factored into price negotiations.
Had the intention towards the employees been communicated two or three years ago, when thoughts began to turn to an Exit, we would have been able to open the toolbox to find a device suitable for the job.
The Enterprise Management Incentive (EMI) scheme, for example, is a very powerful tool to create alignment between would-be vendors, and the key team members. The scheme works very well where typically:
- It is expected that equity value will increase over the course of a few years leading up to a sale of all of the shares in the company;
- Immediately prior to a sale, the scheme participants are able to exercise an option to acquire shares at a price which is geared towards what the equity value was at the inception of the scheme;
- The exercise price is agreed with HMRC as representing equity value at the inception of the scheme, meaning no income tax or NI charges will apply either at inception or at the time of the sale;
- There is a mechanism so that the price paid for the shares by the participants will, practically speaking, simply represent a deduction from the proceeds they receive from the buyer of the company;
- The options are structured so that growth in equity value between the inception of the scheme and the sale will be subject to Capital Gains Tax rather than Income Tax, which in turn creates the possibility of an effective 10% tax rate with ER; and
- The scheme participants stand to walk away with an amount of money that is sizeable without being life-changing as, in many cases, a purchaser will want some or all of the participants to stay in the business rather than retire to the beach.
The introduction of an EMI scheme can play a key part in your exit plan, and can not only provide a way to reward your loyal employees, but also contribute to creating a value on exit that may not otherwise have been achieved. Consultation with your advisers at an early stage is recommended.
If you have any questions or would like to discuss this issue further, please do not hesitate to contact me or visit our Corporate Finance page.
Alternatively, contact your usual UHY adviser or fill out our contact form.
