Employee Share Option Schemes - differences in rules between different schemes

Rule Differences Between Option Schemes - Legal Requirements vs Employer Choice

Share option schemes are a powerful tool for companies looking to attract, retain and motivate key staff by offering them the opportunity to share in the business's future success. However, the choice between EMI, CSOP and unapproved schemes involves complex considerations around tax efficiency, flexibility and legal compliance.

Some share scheme rule requirements are legally mandatory and other differences are as a result of employer commercial choices. Understanding these distinctions is crucial for both employers designing schemes and employees considering participation.

EMI Scheme Rules

In general terms employers have a lot of flexibility with EMI rules. EMI must include statutory tax-related provisions and require clauses to maintain tax-advantaged status while allowing commercial flexibility.

Legal Requirements

• Must include ability to exercise within 40 days of change of control - required by law to ensure option holders can participate in a sale and not lose option value. Must specify notification process and consequences of non-exercise

• Must state individual and company limits - rules need to specify the £250,000 per person and £3 million company limits as these are key qualifying conditions. Must include mechanism for checking compliance

• Must specify market value at grant - required to show consideration for tax benefits and must reference HMRC valuation agreement. Rules should specify valuation mechanism and process for agreement

• Must include working time declaration - rules need employee confirmation of hours worked as this affects tax qualification. Should include ongoing obligation to notify changes

• Must define eligible employees - required to clearly state who can receive options based on statutory criteria. Must include provisions for dealing with employees who become ineligible

Common rules inserted by employers in EMI options schemes

• Vesting provisions - company can choose any vesting schedule that suits business needs - monthly, annual, cliff vesting. Can include acceleration provisions for good performance

• Performance conditions - free to include any measurable business or personal targets for exercise. Can be adjusted for market conditions with board discretion

• Exercise periods - can set any exercise window up to 10 years that aligns with business goals. Usually includes early exercise triggers for certain events

• Leaver provisions - can create any good/bad leaver definitions and consequences that support retention. Often includes board discretion to modify treatment

• Share rights - while must be ordinary shares, can include standard shareholder protections and restrictions. Usually includes pre-emption rights and transfer restrictions

• Corporate events - beyond minimum 40-day rule, can add provisions for any type of transaction. Often includes specific terms for IPO or asset sales

CSOP option scheme rules

Generally more rigid than EMI scheme designs in terms of the legal requirements, resulting in less room for employers to impose rules.

Legal Requirements:

• Three-year minimum holding period - statutory requirement for tax benefits, cannot be shortened under any circumstances except death or disability. Must specify exact timing

• Must be ordinary shares - cannot use preferred or growth shares. Shares must have full voting, dividend and capital rights

• Must state £60k individual limit - documentation must specify statutory maximum and include mechanism for valuing and monitoring this limit

• Must include prescribed change of control provisions - specific legal wording required for qualifying corporate events. Limited flexibility in drafting

• Must maintain market value exercise price - cannot be set lower than market value at grant date. Rules must specify valuation mechanism

Employer Choices

• Vesting schedule (after 3 years) - can structure vesting after minimum period ends but must respect three-year holding requirement.

• Leaver treatment (within statutory framework) - limited flexibility within good/bad leaver definitions but must maintain three-year requirement

• Administrative provisions - can determine processes for notices, exercise, and share issuance within statutory framework

• Corporate event treatment (beyond statutory minimum) - additional provisions for events not covered by statute but must maintain key protections

• Performance conditions (but rarely used) - can add but must work within three-year restriction and not undermine statutory requirements

Unapproved Scheme Rules

Generally, the design of an unapproved scheme can be complex but also offers employer freedom of design but higher tax cost, often used for senior executives.

Legal Requirements

No specific company law requirements over and above general company and employment law compliance

Employer choice

• Vesting terms - complete freedom on timing, conditions and structure. Often includes complex good/bad leaver variations.

• Performance conditions - can be as simple or complex as desired, often including market and non-market conditions.

• Leaver provisions - full flexibility on treatment of different types of leavers with varying notice periods and consequences.

• Corporate event provisions - can cover any type of transaction with any treatment, including complex ratchets

• Exercise provisions - no restrictions on when or how options can be exercised, can include complex pricing mechanisms.

• Clawback rights - can include any triggers for option/share recovery, usually linked to misconduct or competition.

• Share rights - can attach to any class of shares with any rights, often including complex waterfall provisions

Contact us

To ensure your share option scheme achieves its commercial objectives while remaining legally compliant and tax-efficient, early legal advice is essential. We can guide you through the complexities of choosing between EMI, CSOP and unapproved options, ensuring your scheme includes appropriate protections while maximising flexibility where commercially beneficial.