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How much will it cost me if I don’t use a share scheme?

Posted on November 18, 2014

The question we’re asked most often about setting up an employee share plans is “how much does it cost?”

Sometimes, it might be better to ask what it would cost if you didn’t put a share plan in place. Take a look at these scenarios:

The cost of recruitment

Here’s a typical example. John runs a successful IT company, BetterByte Ltd.  He’s been thinking about selling up and he really wants to tie in his two top software developers, Lisa and Tina, and 5 members of their team to help grow the company to a certain value to maximise his proceeds. In fact, he’s been talking about this for some time, and Lisa and Tina are really keen.

But business gets in the way. Work is madly busy. Nothing gets done. And eventually Tina, fed up with the promises of jam tomorrow, gives up and goes off to a job with a higher salary.

Tina was earning £80,000. To recruit another Tina will cost BetterByte around £20,000 - £30,000 in recruitment charges – plus the time costs involved in the recruitment process. The cost in stress to Lisa and her team, picking up Tina’s work in the meantime, and arranging the handover to her replacement when she arrives, isn’t costed – but there is undeniably a cost there. 

A simple exit only EMI scheme for 7 or 8 people is going to be a whole lot cheaper than replacing key people – even without taking into account the hidden costs.

The cost of retention

BetterByte puts in a simple exit only EMI scheme. At grant, the Company is worth about £2m.  Options are granted to Lisa over 100 shares, around 5% of the share capital. HMRC agrees an exercise price of £350 per share for the EMI plan (taking into account a fairly typical private company discount). 

After 3 years, the Company is sold for £8 million, and Lisa’s share of the sale proceeds is around £380,000. Under EMI, she doesn’t pay income tax or NICs on the exercise of the options, but instead pays capital gains tax on the increase in value; she also benefits from Entrepreneurs’ Relief, so the tax rate is only 10%.

Taking into account the exercise price, the annual CGT exemption of £11,000, and the 10% tax rate, let’s say that Lisa’s net gain is approximately £300,000.

There are no NICs costs for the company on exercise of the options.

And on exercise of the options, the Company benefits from a corporation tax deduction equivalent, broadly, to the total gain made by any participants. Based on Lisa’s gains, that amounts to a deduction of around £70,000.

How much would it have cost the Company to provide Lisa – earning £70,000 p.a. and a higher rate tax payer - with £300,000 net, in cash?

The Company would need to gross up Lisa’s payment to take account of Income Tax and employee’s NICs. It will also need to cover employers’ NICs. In total, to achieve a net payment of around £300,000, the gross cost to the Company will be around £480,000 – an additional £180,000.

So if you want to hold on to your good staff, don’t assume that a share scheme will break the bank. On the contrary, it might prove to be an excellent investment.

 
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