Employee incentive schemes allow growing businesses to offer key people a stake in future success. For founders, the legal structure matters: sharing financial rewards need not mean handing over day-to-day decision-making, but poorly defined rights can create difficulties when employees leave or investors arrive.
Herrington Carmichael advises businesses on the corporate arrangements behind employee incentive schemes. The starting point is to decide what employees should receive, when they should receive it and which decisions should remain with existing owners.
Why Are Employee Incentive Schemes a Strategic Growth Tool?
Employee share schemes can support recruitment and retention by linking reward to business performance. A prospective senior hire may value participation in future growth alongside salary, whilst existing employees can earn benefits through continued service or agreed performance milestones.
The corporate objective should be specific. Retaining a management team through a sale requires different terms from rewarding annual profitability. Clear objectives help determine the award, vesting conditions and eventual payment mechanism, rather than allowing tax considerations alone to dictate the structure.
Which Employee Share Scheme Suits a Growing Business?
The appropriate employee share scheme depends on eligibility; the intended reward and the rights founders are prepared to share. Comparing the position at grant, on departure and at exit is more useful than comparing scheme labels alone.
EMI Options: Participation Before Share Ownership
EMI options give selected employees a right to acquire shares later, subject to the option terms. Employees do not become shareholders merely because options are granted; exercise may depend on continued service, performance or a sale.
Enterprise Management Incentives can offer favourable tax treatment where the relevant requirements are satisfied. Company activities, independence, size and employee eligibility must be checked carefully against the statutory requirements and current HMRC guidance, with specialist tax advice obtained where appropriate. Founders should also review the rights attached to the shares employees will acquire.
The EMI limits were expanded from 6 April 2026, allowing more growing companies to qualify. Eligibility and the applicable limits should nevertheless be checked carefully, particularly where the company is part of a group or carries on excluded activities.
Growth Shares: Rewarding Future Value Creation
Growth shares usually entitle employees to participate in value above a defined hurdle. They can help distinguish value already built by founders from the future growth employees are being encouraged to deliver.
Unlike unexercised options, growth shares confer share ownership when issued. Their voting, dividend and capital rights require careful drafting. The hurdle, valuation and interaction with other share classes also need review; a low initial value does not automatically make an award tax-free.
Other Incentives: LTIPs, CSOPs (EMI2s) and Unapproved Options
A Company Share Option Plan, which is expected to be rebranded as EMI2 from 6 April 2027, may provide a tax-advantaged alternative where EMI is unavailable, subject to its own conditions. Unapproved options offer another route, although the tax treatment differs.
Long-term incentive plans can use shares, options or cash-based arrangements to reward management for achieving longer-term growth or exit objectives. Depending on the structure, an LTIP can help retain and align key managers without immediately transferring control. It may also form part of a longer-term management succession strategy, including preparing and incentivising a management team ahead of a potential MBO.
Cash-based LTIPs or phantom share arrangements can link rewards to business value without issuing shares. Although they avoid equity dilution, they create payment obligations that should be considered alongside cash flow, future investment and transaction funding.
How Can Founders Reward Employees Without Losing Control?
Founders can often separate economic participation from voting and management rights, although the scheme, constitutional documents and relevant tax and employment arrangements must be considered together.Giving employees an interest in sale proceeds does not necessarily require giving them board representation or a veto over business decisions.
However, retaining votes does not remove economic dilution or all shareholder protections. Non-voting shareholders may still have statutory rights, including potential protection against unfairly prejudicial conduct under the Companies Act 2006. The relevant questions extend beyond the percentage awarded:
- Define voting rights: identify which decisions employees can influence and which require founder consent.
- Model dilution: calculate ownership after all outstanding options are exercised and anticipated investment is included.
- Align documents: ensure articles, shareholders’ agreements and scheme rules work together.
- Control transfers: address departure, permitted transfers and participation in a company sale.
Common Mistakes When Implementing Employee Incentive Schemes
The principal risks arise when commercial promises are made before their legal and financial consequences have been agreed. An apparently straightforward offer can leave employees and shareholders with different expectations.
Businesses should avoid:
- Promising an undefined percentage: clarify the share class, calculation basis and treatment of future dilution.
- Leaving departure terms unresolved: define vesting, good and bad leaver treatment, exercise periods and any compulsory transfer price.
- Assuming tax relief applies: check eligibility, valuation, notifications and ongoing reporting with appropriate advisers.
- Overlooking approvals: review allotment authority, pre-emption rights and existing shareholder or investor consent requirements.
- Overcomplicating rewards: explain when value can be realised and what might prevent a payout.
Preparing Employee Incentives for Investment or Business Sale
Incentive arrangements should explain how employee rights interact with new investment and sale proceeds before a transaction begins. This is part of business exit planning, rather than an issue to defer until a buyer is found.
Model the distribution of proceeds across realistic sale values, taking account of growth hurdles, investor preferences and option exercise costs. A headline equity percentage may produce a different return once those provisions operate together.
Scheme documents should also address acceleration of vesting, exercise or replacement of options, and any obligation to sell alongside majority shareholders. Clear records of grants, approvals and tax compliance help advisers identify issues before negotiations are advanced. Incentives should support a transaction without promising employees outcomes the documents cannot deliver.
How We Can Help with Employee Incentive Schemes
Herrington Carmichael’s Corporate team can help your business select and document an incentive structure that reflects its ownership and growth plans. Our team can assist with:
- Comparing EMI options, growth shares and alternative arrangements;
- Drafting scheme rules, option agreements and share rights;
- Aligning shareholder protections, leaver provisions and sale arrangements.
If you are considering an award to a key employee, contact us to discuss how the proposed reward could affect founder control, existing shareholders and future investment.
