A Guide for Owner-Managed Businesses: Choosing the Right Staff Incentive Strategy

Rewarding employees is central to building a committed, high‑performing workforce. A share incentive programme enables employees to participate in the company’s growth, aligning their interests closely with those of the employer.

This article provides an overview of key incentive structures available to employers and highlights the practical questions employers should consider when designing a scheme.

Types of employee incentives

Enterprise management incentive (EMI) schemes

EMI schemes are highly tax‑efficient arrangements available to qualifying companies. Employees receive options to acquire shares at a set exercise price, often exercisable on an exit or after set vesting milestones.

Provided the scheme meets certain statutory conditions, no income tax or national insurance contributions (NICs) are payable by the employee on the grant or exercise of an option (provided the exercise price is at least equal to the market value of the shares at the time of granting the option). Only capital gains tax is due on any gain made on sale of the shares. In addition, a corporation tax deduction may be available for the employer on exercise of the options.

Company share option plans (CSOPs)

CSOPs may be available to companies which do not meet the EMI criteria. This is because the scheme is open to companies of all sizes and there is no requirement that the company carries on a qualifying trade, as is required by the EMI rules.

As with an EMI scheme, employees are granted options to acquire shares in the company. Where the criteria in the CSOP rules are met, the tax treatment for both employers and employees in relation to shares issued under a CSOP is broadly the same as for shares issued under an EMI scheme. CSOPs are however more limited in some respects than the EMI scheme, in particular an individual is limited to holding options over shares with a total value of up to £60,000 (as opposed to £250,000 for EMI options) and generally the options cannot be exercised for 3 years from the date of grant if the favourable tax treatment is to be obtained.

Unapproved share schemes

It is also open to employers to set up an employee share scheme which falls outside the HMRC‑approved frameworks. This type of scheme offers complete flexibility in how awards are structured. Vesting conditions, valuation methods and leaver provisions can all be tailored to the employer’s particular requirements. However, they lack the tax advantages of an EMI scheme or a CSOP, meaning employees may face income tax and NICs on the exercise of the options. This can be particularly problematic if the options are not being exercised immediately prior to a sale of the shares, as the employee will not have any sale proceeds from which the tax can be paid.

Growth shares

Companies may issue growth shares to employees to allow them to participate in any increase in the value of the company above a fixed hurdle. This is a useful mechanism when founders wish to avoid diluting the pre-existing value of the company. This also has the benefit of making the shares more affordable for employees (if issued immediately rather than under one of the above schemes) as the market value of the growth shares will be lower given the nature of the economic rights.

Growth shares also enable founders to preserve their existing level of control, as this class of shares typically carries only very limited voting rights.

Phantom equity (or shadow equity)

Phantom equity mirrors the financial benefits of share ownership without issuing actual shares. Employees receive a cash payment linked to the increase in the value of the company’s shares. This avoids the dilution of the existing shareholder(s) and the need to comply with the formalities of an employee share scheme. At the same time, there is a direct correlation between the increased success of the business and the reward received by the relevant employee(s).

Key considerations for employers

The right approach will vary depending on the context for each company. There are a number of factors to consider when making this decision, including the following:

1. Timing: upfront shares or future ownership?

Issuing shares immediately can foster early alignment and provide a more tangible incentive for staff. However, it may also create upfront tax liabilities and introduce new shareholder rights. Options, growth shares and phantom equity allow employees to benefit only once value has been created and are often more tax‑efficient and commercially manageable.

2. Level of control and governance

Employers should consider to what extent existing shareholders are willing to be diluted and whether employees receiving shares will be permitted to hold voting rights. There are also additional questions to be considered such as what happens when an employee leaves the business.

3. Tax efficiency

Tax outcomes vary significantly. EMI schemes and CSOPs provide statutory tax advantages and growth shares can help to mitigate tax liabilities if structured correctly; whereas phantom equity is generally taxed as income. Understanding the tax profile for both the company and employees is key to choosing the right model.

Whichever incentive structure an employer chooses, it is essential to comply with the specific statutory and procedural requirements in order to preserve the tax-efficient treatment and avoid any unintended consequences for both the company and its employees.

If you would like help navigating these decisions, please contact a member of the Bates Wells team. We can guide employers through each stage of the process, giving comfort that the appropriate legal and governance requirements have been satisfied.