What to do if EMI is not available…

1. What to do if EMI is not available… Amanda Flint Contact: T: 07786 967577 E: af@amandaflint.com or from 1st July2012 amanda.flint@uk.gt.com

2. EMI is not available… • This may be because: • Your Company does not qualify (this might be because your trade does not qualify; or • The individual that you want to benefit does not qualify e.g. not working enough hours; or • Your shares do not qualify; or • You have too many employees. • You can use EMI but you have no more capacity (now personal limit of £250k per person – measured at grant)

3. First step: go back to your objectives “We want our directors to demonstrate commitment by ‘pay to play’ but we understand that they are at a stage in their lives where they are cash poor!” “I want executives to participate in a future exit – but not until then” “The executives should be treated as investors – we would like them to put up cash into the company” “I am keeping a tight control on cash and so it is important that the directors have a meaningful long-term incentive” “We know that our management team is key to our future success and we want them to share in the growth it has created” “Achieving capital gains tax treatment is an important financial element of the incentive for executives.”

4. Ask some questions: • Valuation is key – don’t forget the minority share holder discount! • What is the realisation point – exit? Or earlier? Who will fund an earlier exit? • What do you want to happen if a participant leaves? • Will there be future generations of executive to participate in the incentive – Or are you mainly focused on the current executives? • Are you prepared to make the incentive valuable from the outset?

5. Solution 1 –share subscription Objectives: • Executive – little cash • Pay subscription price of nominal value • Get shares up front – benefit from future growth • Can add conditions to shares – forfeit if leave employment • Need tax election COMPANY Shares Cash EXECUTIVE

6. Implications & Use – share subscription Impact • Any difference between nominal value & market value is subject to income tax; • Often no PAYE/NIC – but depends on circumstances; • No advance valuation can be agreed with HMRC & may have to wait until self assessment tax return is submitted • Executive is a shareholder Useful where: • The value (for tax purposes!) is very low – it will not have NO value; • The nominal value of the shares is low; • You want the executive to be a shareholder; • The implications if they leave are well thought through – i.e. who will buy the shares, at what price

7. Points to note – share subscription Probably helpful to undertake a valuation exercise at acquisition – HMRC tend to use hindsight! Limited shelf life – as the company grows, shares will become more valuable & entry cost will become unattractive Uncertainty of tax treatment will not suit very cautious executive But: part of shareholder ‘team’ from the outset

8. Solution 2 – partly paid shares Objectives: • Executive – little cash • Acquire shares at current market value – but leave subscription outstanding • Get shares up front – benefit from future growth • Can add conditions to shares – forfeit if leave employment • Tax election prudent COMPANY Shares Owes subscription price EXECUTIVE

9. Implications & Use – partly paid shares Useful where: • You want the executive to buy shares at market value but they have no cash available; • The exposure level is acceptable • You want the executive to be ‘on risk’ – pain as well as gain! • There is an exit likely at some point • The implications if they leave are well thought through – i.e. who will buy the shares, at what price Impact • No up front acquisition cost; • No up front income tax charge – but may be on going tax • No advance valuation can be agreed with HMRC – may need adjuster clause • Shares subject to a call – tax due if disposed of without paying up • Executive is on risk for an amount equal to market value on acquisition

10. Points to note – partly paid shares • Probably helpful to undertake a valuation exercise at acquisition – HMRC tend to use hindsight! • Can use an Employee Share Trust to buy shares later if necessary • Recent tax changes mean that now need to use new issue shares only • Very difficult to unscramble – tax cost of exit even if value falls

11. Solution 3 – loan to buy shares Objectives: • Executive – little cash • Acquire shares at current market value • Get shares up front – benefit from future growth • Can add conditions to shares – forfeit if leave employment • Tax election prudent COMPANY Cash Shares Cash EXECUTIVE

12. Implications & Use – loan to buy shares Useful where: • Same as partly paid but: • Where you might want to release executive from obligations in certain circumstances (e.g. hardship, extreme economic conditions, death) Impact • Same as partly paid but: • Not subject to a call on shares • Easier to write off loan if you wish to do so in the future

13. Points to note – loan to buy shares • Same as partly paid but: • Recent tax changes mean that loan should not come from a third party unless it is a commercial loan • Easier to write off loan – so long as this is lawful for insolvency law purposes

14. Solution 4 – flowering shares Unrestricted share value Objectives: • Executive – receives shares up front whose value ‘blossoms’ if conditions are met; • If conditions are met – restrictions fall away; • Can be forfeited if leaves employment etc. ‘Flowering’ share value EXECUTIVE Pays subscription price & receives shares

15. Implications & Use – flowering shares Impact • Tax trap: If you don’t pay the full unrestricted share value when you acquire the shares, there will be income tax to pay when you sell them • Can make election and pay income tax up front on value you may not receive; OR • You can pay income tax when you dispose of the shares – value could be much higher TAX TRAP Unrestricted share value ‘Flowering’ share value Pays unrestricted share value or ‘Flowering’ share value EXECUTIVE

16. Points to note – flowering shares • Still useful if tax is not the main issue • Need to manage expectations & communicate regularly and clearly on the tax treatment • May be helpful where share value is low and entry cost is also low • Can combine with loan

17. Solution 5 – growth shares Ordinary share capital Ordinary share capital Growth shares EXECUTIVE Growth shares created Objectives: • Executive – receives shares from a new class that only has value if company value grows • Value low – whether or not restricted (may be hurdle); • Can be forfeited if leaves employment etc. – will need to use tax election on acquisition for tax benefits

18. Implications & Use – growth shares Useful where: • The current share value is high but you want to reward executives for future performance; • You want executives to become shareholders from the outset; • There is a change of ‘generation’ at the company Impact • New class of shares – amend articles of association; • No advance valuation process with HMRC but a valuation exercise advisable – may be able to agree with HMRC afterwards; • Executive a shareholder from the outset

19. Points to note – growth shares • The new class of shares and the corresponding low value has a short shelf life – especially in a fast growing company; • If you will have a train of new joiners over the next few years – you may need to create a new class of shares periodically – which may mean a very complicated share capital structure; • This could make communications on value opaque and might also make an exit complicated

20. Solution 6 – joint ownership Ordinary share – current value Ordinary share – future value EXECUTIVE Trustee Objectives: • Executive – receives future growth on existing ordinary shares • Value low – whether or not restricted (may be hurdle); • Can be forfeited if leaves employment etc.

21. Solution 6 – joint ownership – additional feature Ordinary share – future value Ordinary share – current value Unapproved option EXECUTIVE Trustee Objectives: • Unapproved option over existing value to executive; • Subject to income tax on exercise – but value fixed at award; • On vesting, executive gets ‘whole’ value of share – initial value subject to income tax, growth subject to capital gains tax – similar to LTIP

22. Implications & Use – joint ownership shares Useful where: • The current share value is high but you want to reward executives for future performance; • You want executives to become shareholders from the outset; • It is likely that you will have a number of senior hires over the next few years Impact • No need for a new class of shares – keeps share capital structure simple; • Can adjust hurdle to regulate up front cost • No advance valuation process with HMRC but a valuation exercise advisable – may be able to agree with HMRC afterwards; • Executive a shareholder from the outset

23. Points to note – joint ownership shares • Simplicity of share capital structure attractive if there is to be a later exit; • Not time sensitive – can adjust as time progresses; • Use of trustee adds third party validity to the arrangement; • Up front tax charge unless pay market value for future interest of shares; • Valuation exercise strongly recommended

24. Summary There WILL be tax implications – and these cannot be left to the individual as the company will have liabilities – advice is essential Don’t forget compliance issues for the company – non-reporting implications can be a high corporate cost! Any non-UK element will need additional tax & legal consideration Up front planning and on-going communication to executives are EQUALLY important