EMI Scheme: What Happens When an Employee Leaves?

Enterprise Management Incentives (EMI) are a brilliant way to attract and retain key people. But what happens to EMI options when an employee resigns, is dismissed, or goes on long‑term leave?

If you’re running a small business, this is exactly when the theory meets reality. Getting your leaver provisions, timelines and tax treatment right will save a lot of headaches - and protect both your cap table and culture.

Below, we break down what UK law expects, how EMI tax rules work on departure, and the practical steps to follow when an employee with EMI options leaves.

What Is An EMI Scheme?

An EMI scheme is a HMRC‑approved share option plan designed for smaller, high‑growth companies. It lets you grant selected employees options to acquire shares in the future, usually at a fixed exercise price. If certain conditions are met, EMI offers very favourable tax treatment under the Income Tax (Earnings and Pensions) Act 2003 (ITEPA), Schedule 5.

In short, EMI can help you compete for talent without immediate cash outlay and align your team with long‑term growth. The terms of each grant are typically set out in two places: your plan rules (the “EMI plan”) and the individual option agreement.

If you’re still setting up your structure, it’s common to coordinate your EMI plan with your wider governance arrangements - things like your Shareholders Agreement, any Vesting Agreement, and senior team members’ Directors’ Service Agreement or Employment Contract.

If you haven’t put a plan in place yet, start by getting your EMI Options designed for your business goals, including how leavers will be treated.

What Happens To EMI Options When An Employee Leaves?

EMI is flexible. The default position is whatever your EMI plan rules and option agreements say. However, there are some common patterns and tax rules to be aware of.

1) Good Leaver vs Bad Leaver

Most plans define “good” and “bad” leavers. The definitions are contractual, but commonly:

• Good leaver: leaves due to redundancy, long‑term ill health, death, or is asked to leave without fault (e.g. role genuinely no longer required). Sometimes retirement is included.
• Bad leaver: resigns voluntarily to join a competitor, is dismissed for misconduct or poor performance, or breaches restrictive covenants.

Why it matters: good leavers may keep more vested options and be allowed to exercise within a set window. Bad leavers usually forfeit unvested options and sometimes even vested options (depending on how tough your plan is). Clear definitions reduce disputes.

2) Vesting On Exit

Unvested options typically lapse on leaving. Some plans permit partial “accelerated vesting” for good leavers (for example, vesting pro‑rata to the date of departure, or acceleration on death). Make sure your vesting schedule dovetails with your commercial aims.

3) Exercise Window

Where leavers are allowed to exercise vested options, the plan will set a deadline (often 30–90 days for voluntary resignations; longer for redundancy or ill health). If the option isn’t exercised by the deadline, it lapses.

4) Disqualifying Event And 90‑Day Rule

Leaving employment (or failing the EMI working time requirement) usually triggers a “disqualifying event” for EMI tax purposes. If the option is exercised within 90 days of the disqualifying event, favourable EMI tax treatment can still apply to the growth up to that event. Exercise after 90 days can lead to less favourable tax on some or all of the gain. We explain this in more detail below - but the key is that timelines matter.

5) Leaver’s Share Rights

When options are exercised, the leaver becomes a shareholder. Think through post‑employment rights: voting, dividends, drag/tag, buy‑back and transfer restrictions should be aligned across your EMI plan, articles and Shareholders Agreement. Many companies require leavers to sell their shares back under a pre‑agreed formula, often documented via a Share Buyback Agreement.

Drafting Leaver Provisions That Work In Practice

The best time to handle leaver scenarios is before they happen. When you design your EMI plan and option agreements, build in practical mechanics that are easy to operate and fair.

Key Choices To Make

• Define leaver categories clearly: Use objective criteria where possible (e.g. “dismissal for gross misconduct following a disciplinary process” rather than vague terms).
• Set vesting schedules: Consider a cliff (e.g. 12 months) and monthly or quarterly vesting thereafter. Decide if you want pro‑rata vesting for good leavers.
• Choose exercise windows: Align with the EMI 90‑day tax window for most leavers to preserve tax efficiency where appropriate.
• State lapse rules: Spell out what lapses on leaving (normally all unvested options; sometimes vested options for bad leavers).
• Include buy‑back/transfer restrictions: Keep your cap table clean. If leavers can become shareholders, ensure there’s a route to buy back or transfer their shares at a pre‑agreed valuation basis.
• Protect the business: Post‑employment Non-Compete Agreement and confidentiality obligations should sit in your employment or director agreements, not the EMI plan, but the plan can reference compliance as a condition of good‑leaver status.

Align With Your Other Documents

Your EMI documents shouldn’t sit in a vacuum. Cross‑check them against your Employment Contract, any Directors’ Service Agreement, your articles and your Shareholders Agreement. Inconsistencies are fertile ground for disputes.

Communicate Terms Upfront

Employees value clarity. When granting options, include a concise summary of key leaver outcomes in the grant letter (with the plan and agreement attached). No one likes surprises when they resign or roles change.

Tax And HMRC Notifications On Leavers

This is where EMI’s rules matter. While your plan defines who gets to keep or exercise options, UK tax law determines how those options are taxed when exercised after a leaver event.

EMI Favourable Tax Treatment (In Brief)

• If EMI conditions are met, on exercise there’s generally no Income Tax or NICs on the uplift between the exercise price and the market value set at grant (subject to proper valuation), and gains on sale are usually subject to Capital Gains Tax (CGT).
• Shares may qualify for Business Asset Disposal Relief if conditions are met, but always get tax advice for current rules.

Disqualifying Events And The 90‑Day Window

Certain events are “disqualifying events” under ITEPA 2003 Schedule 5 - for example, ceasing to meet the EMI working time requirement or leaving employment with the granting company or qualifying subsidiary. From the date of a disqualifying event:

• If the option is exercised within 90 days, favourable EMI tax treatment typically applies to growth up to the disqualifying event.
• If exercised after 90 days, some or all of the subsequent growth may be subject to Income Tax/NICs, not CGT.

Practically, many employers set the exercise window for most leavers at 90 days to align with these rules. That said, your commercial policy might be more generous for certain good leaver scenarios - just be aware of the tax consequences for the individual (and any reporting obligations for you).

HMRC ERS Reporting

EMI options must be registered and annual returns filed via HMRC’s Employment Related Securities (ERS) service. On leaver events, you’ll need to report lapses, exercises and disqualifying events in your next annual return, and certain events may need more immediate attention (for example, if there’s a variation to terms that could itself be a disqualifying event). Keep your records accurate and timely.

Because tax treatment can be fact‑sensitive, it’s wise to build a standard process with finance and legal input for every leaver who holds EMI options.

Employer Checklist When An EMI Employee Leaves

When someone with EMI options resigns or is terminated, a simple, repeatable process will keep you compliant and consistent. Here’s a practical checklist to adapt for your business.

1) Confirm Leaver Category And Last Working Day

• Determine if the employee is a good or bad leaver under your plan rules.
• Record the effective date (which often triggers a disqualifying event for EMI).

2) Check Vesting And Lapse

• Calculate vested vs unvested options as at the leaving date, including any pro‑rata or accelerated vesting if applicable.
• Confirm which options lapse immediately and which may be exercised.

3) Communicate The Exercise Window

• Send a clear letter setting out: vested options, exercise price, last exercise date (e.g. 90 days), and mechanics for exercise and payment.
• Remind the individual of any ongoing obligations (confidentiality, post‑termination restrictions, return of property).

4) Manage Exercise And Share Issue

• Provide practical steps for exercise (notice, funds, timeline, board approvals).
• If the plan requires it, arrange for a buy‑back or transfer after exercise using a Share Buyback Agreement or other transfer documentation.

5) Update Your Cap Table And Records

• Update option registers to show lapsed and exercised options.
• Update your shareholder register for any shares issued or bought back.
• File ERS returns reflecting the leaver event and any exercise.

6) Align With Employment Exit Documents

• Make sure the employment termination paperwork (for example, a settlement agreement if used) doesn’t conflict with the EMI documents.
• Confirm restrictive covenants and confidentiality in the Employment Contract or Directors’ Service Agreement, and consider separate post‑termination protections such as a Non-Compete Agreement where appropriate.

7) Plan For Replacement Grants

• If a key person leaves, consider whether to re‑grant those options to a new hire under your EMI Options pool.
• Check if your pool size or plan rules need refresh, or if you need to adjust vesting to support hiring goals.

Key Takeaways

• EMI is flexible - but your plan rules and option agreements govern what happens when an employee leaves, so draft clear good/bad leaver definitions, vesting, lapse and exercise windows from day one.
• Leaving employment is usually an EMI disqualifying event. If a leaver exercises within 90 days, favourable EMI tax treatment can still apply to growth up to the event; exercise after 90 days may reduce those benefits.
• Coordinate your EMI plan with your Shareholders Agreement, Vesting Agreement, and core contracts like an Employment Contract or Directors’ Service Agreement to avoid conflicts and keep your cap table tidy.
• Have a repeatable leaver process: confirm leaver category, calculate vesting and lapse, set the exercise deadline, handle any buy‑back using a Share Buyback Agreement, update ERS filings, and keep your registers up to date.
• Timely communication is key. Provide the leaver with a clear written summary of their options, the last exercise date, and the steps to exercise - and document everything.
• Tax and reporting can be nuanced. Build in-house checklists and get tailored advice where needed so you remain compliant and preserve EMI benefits where possible.

If you’d like help drafting or updating your EMI plan and leaver provisions - or you want support running a clean exit process - you can reach us on 08081347754 or team@sprintlaw.co.uk for a free, no‑obligations chat.