EMI options: how to grant UK startup equity without a tax bill

Equity is the only currency a UK startup can offer against the salaries London tech pays from day one (a senior engineer at Stripe or Google London clears 130,000 pounds base before bonus). HMRC knows this and runs the Enterprise Management Incentive scheme, an option scheme so generous that most other countries do not have an equivalent. Use it correctly and your engineers pay 10 percent capital gains at exit; use it carelessly and they pay 47 percent income tax plus employer National Insurance on the spread.

The legal frame is concentrated: Schedule 5 of the Income Tax (Earnings and Pensions) Act 2003 sets every EMI rule that matters, HMRC's Employee Tax Advantaged Share Scheme User Manual interprets it in practice, and Section 431 elections under ITEPA 2003 cover the share-restriction trap. Miss one of those three and you are running an unapproved option scheme without knowing it.

Three structures, three tax lives

• EMI options: HMRC-approved options, granted at AMV agreed with HMRC, no income tax or NI at grant or exercise (if exercise price equals AMV), 10 percent business asset disposal relief at sale held more than two years from grant. Individual cap: 250,000 pounds of unrestricted market value of options held at grant (ITEPA 2003 Sch.5 para.5). Company cap: 3 million pounds of unrestricted market value across all EMI options outstanding (Sch.5 para.7).
• Unapproved options: no HMRC blessing, taxed as employment income on the spread between exercise price and market value at exercise (income tax up to 45 percent plus employee NI 2 percent plus employer NI 13.8 percent unless transferred to the employee). Used when EMI eligibility is missed or for non-UK staff.
• Growth shares: a separate class of shares that participates only in value above a hurdle set today. The hurdle is the company's current value, so the shares carry low value at issue and the holder pays capital gains rather than income tax at sale. Useful for board-level hires above the EMI cap, but require notarised valuations and a careful articles amendment.

EMI eligibility, the three traps that catch first-time founders

First, the company. EMI is for trading companies with gross assets under 30 million pounds, fewer than 250 full-time-equivalent employees, and no excluded activities (banking, property development, legal and accountancy services, ship building, farming) under ITEPA 2003 Sch.5 paras.8-23. SaaS, fintech (subject to specifics), bio, consumer apps are all fine. Second, the option holder. They must be an employee (not a contractor) and commit at least 25 hours per week or 75 percent of their working time to the company under Sch.5 para.26. Founders moonlighting at another job fail this. Third, the AMV. You must agree the share's actual market value with HMRC's Shares and Assets Valuation team before grant; the agreement is valid for 90 days. Grant without it and you have probably under-valued the shares, which triggers an income-tax charge on the discount.

What if I want to give EMI options to a brilliant contractor who refuses to come on payroll?

You cannot. EMI requires an employment contract under ITEPA 2003 Sch.5 para.24, and HMRC reads this strictly. You have three real options: persuade them onto payroll for at least 25 hours a week, issue unapproved options and accept the worse tax outcome, or use growth shares with a clean Section 431 election. The IR35 / off-payroll rules under Chapter 10 ITEPA 2003 also bite here: if your contractor operates through a personal service company and your medium or large company controls how they work, you are deemed employer and owe PAYE plus NI on their fees anyway. The cheap-looking contractor often costs more than the EMI-eligible hire.

Section 431 elections, the form everyone forgets

If your shares are restricted (which they are, in any sensible UK startup, because they carry leaver provisions, drag-along and transfer restrictions in the articles), HMRC values them lower than unrestricted shares. That helps at grant but hurts at sale: a portion of the gain becomes employment income rather than capital gain. A joint Section 431(1) election under ITEPA 2003, signed by employer and employee within 14 days of acquisition, treats the shares as if they were unrestricted, fixing the tax at grant and ensuring the entire later gain is capital. Sign the election for every EMI grant without exception. It is one A4 page, costs nothing, and saves five-figure sums per holder at exit.

Vesting, exercise window, leaver terms

Four years with a one-year cliff is standard, mirroring the US convention but implemented through HMRC's accepted EMI mechanics. Vesting can be time-based, performance-based, or exit-only (the option only vests on a qualifying exit). Exit-only is increasingly common because it simplifies leaver disputes and matches investor expectations. The exercise window after leaving employment is 90 days under ITEPA 2003 Sch.5 para.39, after which the option lapses or converts to unapproved if exercised later. Leaver classifications (good, bad, intermediate) sit in the option agreement, not in HMRC rules, so you have full contractual freedom there.

When does growth share treatment beat EMI?

Three scenarios. First, the senior hire's grant exceeds the 250,000 pound EMI individual cap (rare at seed, common at Series B). Second, the company has already issued more than 3 million pounds of EMI value (the company cap) so further EMI is blocked. Third, the recipient is a non-employee strategic adviser or non-executive director. In any of those, growth shares deliver capital-gains treatment without EMI eligibility, but they require a notarised actuarial valuation of the hurdle, a class-rights amendment to the articles, and a Section 431 election. Budget 5,000 to 10,000 pounds in fees per growth-share class.

Annual filings nobody warns you about

Once you grant your first EMI option, the company owes HMRC two filings every year. First, the EMI notification, due within 92 days of grant via HMRC's ERS Online service (the deadline is unforgiving and missing it disqualifies the option). Second, the annual EMI return (form 40), due by 6 July following the end of the tax year, listing every grant, exercise, lapse and leaver during the year. Both are free to file but the consequences of missing them are severe: HMRC can deny EMI treatment retroactively, turning a 10 percent capital-gains exit into a 47 percent income tax event. Put a recurring calendar entry on day one.

Pool size: what do UK seed investors actually expect?

A typical UK seed option pool sits between 10 and 15 percent of fully diluted shares, often 12.5 percent as a working default. The BVCA model term sheets assume the pool is created pre-money so the dilution lands on existing shareholders, not the new investor. Investors will require the pool to be topped up to a target size (commonly 10 percent post-Series A), so reserving 12.5 percent at seed gives you 18 to 24 months of hiring runway before refreshing. Below 10 percent, expect a top-up demand in the term sheet; above 18 percent, expect a question about why you over-reserved.