Alex is Sprintlaw’s co-founder and principal lawyer. Alex previously worked at a top-tier firm as a lawyer specialising in technology and media contracts, and founded a digital agency which he sold in 2015.
Contents
Attracting, motivating, and retaining top talent are constant challenges for businesses-especially startups and ambitious small companies working hard to compete with larger firms. If you’re looking for a way to engage your team and ensure everyone’s working towards shared success, an Employee Share Scheme (ESS) could be a game changer.
These schemes do more than just boost morale-when structured carefully, they can also unlock powerful tax advantages for both your business and your employees. But, as with most things in business, it’s crucial to get the set-up and compliance right from the very start.
In this guide, we’ll walk you through what employee share schemes are, why they matter, the key legal and tax considerations, and practical steps to get started. We’ll also highlight some common pitfalls, and explain how professional advice can save time, money, and stress down the track. Let’s dive in!
What Is an Employee Share Scheme?
An Employee Share Scheme (ESS)-sometimes called a staff share option scheme or employee share plan-enables your employees to become shareholders in your company. This typically happens by:- Giving employees shares outright (sometimes as a reward for performance or loyalty),
- Offering them the option to purchase shares at a fixed or discounted price, or
- Allowing them to buy shares in the future through “share options” (which we’ll explain below).
Why Introduce an Employee Share Scheme?
There are plenty of reasons businesses-especially fast-growing SMEs and tech startups-turn to employee share schemes:- Incentivise performance: Employees with “skin in the game” are more motivated and invested in the company’s growth.
- Boost recruitment and retention: A compelling ESS can give you a competitive edge in attracting and retaining key talent, especially when cash salaries are stretched.
- Foster company loyalty: Sharing ownership builds a culture of mutual commitment and shared purpose.
- Reward and recognise: Share schemes can be a meaningful way to acknowledge outstanding contributions or loyalty.
- Tax efficiency: Certain schemes offer appealing tax treatment for both your business and your employees (more on this soon).
What Types of Employee Share Schemes Are There?
The UK offers a range of approved and unapproved employee share schemes, each with its own rules, tax implications, and suitability for different company stages. Here are the main options:1. Enterprise Management Incentives (EMI) Scheme
The EMI is hugely popular with UK startups and SMEs (with assets under £30m and fewer than 250 full-time employees). It lets you grant employees options to buy shares at a set price. If the value of the shares rises, employees benefit from that “upside”-and, crucially, they often pay less tax on their gains. Read more about the details and advantages here.2. Share Incentive Plan (SIP)
With a SIP, employees can receive free shares (up to £3,600 per year), buy shares from their salary (up to £1,800 annually), and benefit from tax breaks if shares are held for at least five years. This is more common in larger, established businesses but can be adapted for growth companies too.3. Company Share Option Plan (CSOP)
Similar to EMI, but without the strict qualifying criteria. CSOPs let you grant employees options to buy shares at a fixed price, with favourable tax treatment if certain conditions are met.4. Unapproved Options/Schemes
If your business or team doesn’t qualify for the above, you can still set up a bespoke “unapproved” share option scheme. However, the tax advantages aren’t as generous-and careful drafting is critical. For a full breakdown of the rules, see our Employer’s Guide To Employee Share Schemes.How Do Share Options Work?
A share option gives an employee the right (but not an obligation) to buy shares in the company at a set price (the “exercise” price) after meeting certain conditions:- Time-based: E.g. options “vest” after two or three years’ service.
- Performance-based: Linked to achieving sales, profit, or growth targets.
- Exit-based: Options become exercisable if the company is sold or listed.
What Are the Taxation Rules for Employee Share Schemes?
Taxation is one of the most important considerations when putting an employee share scheme in place. UK tax rules can be generous for the right scheme, but can also sting if you’re not careful. Here are some key points (with a focus on share options):Tax on Grant
Most approved schemes (like EMI, CSOP, SIP) don’t trigger income tax or National Insurance when options are granted-so your employees won’t pay tax until they actually exercise their options and receive shares (or sell those shares).Tax on Exercise
- Under an EMI scheme, if options are exercised at a price at least equal to market value when granted, there’s no income tax or NICs to pay on exercise (with some exceptions).
- If options are exercised at a discount (i.e. below market value), the difference may be subject to income tax.
- Unapproved schemes usually trigger an income tax liability on any gain between the option price and market value at exercise.
Tax on Sale (Capital Gains)
- If an employee sells shares acquired through an approved scheme, any “profit” (i.e. increase in value since exercise) is usually taxed as a capital gain-often at lower rates than income tax.
- This means EMI and other approved schemes can be very tax-efficient compared to paying bonuses in cash!
What Should You Consider When Setting Up an Employee Share Scheme?
Introducing an ESS is a big step-so it’s wise to think through the details before you get started. Here are some key questions to answer:1. What Are the Eligibility Criteria?
Who do you want to offer shares or options to? All employees, or just key team members? Do you want to incentivise new hires, or reward long-serving staff?2. What Type of Shares Will You Offer?
You can issue ordinary shares (with full voting and dividend rights), or create a special class (with limited or no voting rights). You might also consider preference shares that offer priority payouts if the company is sold.3. What Rights Will Attach to the Shares?
- Voting rights (do you want employees to have a say at shareholder meetings?)
- Dividend rights (will employees share in profits paid out to owners?)
- Rights on exit (do their shares convert or get bought back if the company is sold?)
4. How Will the Scheme Be Funded?
- Will you give shares for free or at a nominal price? (Good for rewarding loyalty or key achievements)
- Will employees “buy in” at market price? (Helps raise funds but can be less attractive as an incentive)
- Will you use share options that vest over time?
5. How Will You Structure Vesting and Leaver Provisions?
“Vesting” schedules determine when employees receive full ownership-helping guard against the risk of someone leaving soon after being granted shares. “Leaver” provisions define what happens to their shares if they leave (voluntarily or not). These should be set out in clear legal documents. Learn more in our guide to share vesting.6. What Are the Notification and Reporting Requirements?
HMRC has specific rules around notification, valuation, reporting, and annual compliance for approved schemes-fail to comply, and the tax benefits could be lost for everyone involved.What Legal Documents and Steps Do You Need?
To properly launch an employee share scheme, you’ll need clear, tailored documentation and company resolutions. Key items include:- A Board Resolution approving the scheme
- A formal plan rules document laying out eligibility, vesting, leaver, and tax provisions
- Option agreements or share subscription letters for each employee (see our Share Subscription Agreement service)
- Shareholders’ agreement (reviewed and updated as needed)
- Formal notification to HMRC and annual filings
What Are The Downsides and Common Pitfalls?
While the rewards are significant, employee share schemes aren’t without risks:- Complexity: Schemes can be complicated to set up and administer, especially when you factor in vesting, leavers, or multiple rounds of funding.
- Tax risks: Small mistakes can jeopardise tax advantages-leading to higher taxes for employees and headaches for your business.
- Governance: Poorly structured schemes can dilute control, increase admin burden, or provoke tensions between shareholders.
- Inflexibility: It’s much harder (and often impossible) to “undo” a scheme than to carefully plan it out at the start.
Frequently Asked Questions About Employee Share Schemes
What Is the Best Type of Employee Share Scheme for a Startup?
For most high-growth SMEs and tech startups, the EMI Scheme offers the best mix of employee incentive and tax efficiency-so long as you meet the qualifying criteria.What Happens If Employees Leave?
You have flexibility here-many schemes “claw back” unvested options and may require departing employees to sell their shares (often at market value) if they leave. The rules need to be watertight and clear to avoid future disputes.Are Employee Share Schemes Taxed as Regular Income?
Approved schemes (e.g. EMI, SIP, CSOP) often shift the main tax from income tax (potentially 20–45%) to capital gains tax (typically 10% or 20%), as long as you follow the rules. Unapproved schemes may trigger income tax when shares are received or exercised.Do You Need to Offer Shares to All Employees?
No. Most schemes let you focus on specific employee groups-such as founders, senior management, or high flyers. Tailoring the scheme keeps it motivational and manageable.Key Takeaways
- Employee share schemes (ESS) give your team a true stake in your business, aligning interests and incentivising growth.
- There are several scheme types in the UK-approved schemes (like EMI, SIP, CSOP) offer powerful tax breaks for eligible businesses.
- Tax rules around employee share options can be complex-proper structure and compliance are crucial to maximising benefits.
- Critical decisions include eligibility, type of shares, funding, vesting, and leaver rules-all of which must be clearly documented.
- Legal and tax advice is essential to avoid common pitfalls and protect both your business and your employees.
