2012 - the year of the entrepreneur
Gloomy economic forecasts and slumps of growth may seem discouraging, but 2012 is set to be the year of the entrepreneur!
Reluctance from banks to lend means that attention has now been focused on other means to fillin the funding gap. Start-ups and small businesses have been encouraged to grow with the support of the Government who seem to be backing the entrepreneurial agenda, Angel investors are still keento invest and crowd funding has exploded onto the scene.
The Enterprise Investment Scheme (EIS) and newly introduced Seed Enterprise Investment Scheme offer great incentives for investments in young companies i.e. those that have been running for no longer than 2 years. If you missed our previous article on this you can find it here.
How can we help Entrepreneurs?
Employee share schemes can be a key tool for start-ups to help recruit talented individuals without the need for top pay packets. Performance conditions are typically attached so that equity is only given away once the profits of the Company have grown, ensuring that, despite the dilution effect, shareholder value increases. Providing considerable tax savings for a company, share schemes also help to conserve cash and provide long term benefits of growth. Putting in place a share scheme is also a method of locking in staff and, in a climate where retention is key, the potential tax benefits that participants enjoy act both as a form of retention and reward thus incentivising employees to help companies grow and ensuring that key talent stays loyal to that employer throughout the exit journey.
The Enterprise Management Incentive (EMI) is usually our recommended share option plan for start-up companies; geared specifically for fast growth. How does this benefit the entrepreneur? No tax or national insurance contributions (for employer or employee) are due on the grant or exercise of a qualifying option under the EMI provided the exercise price is not less than fair market value at the date of grant. On the sale of shares acquired through an EMI the gains are taxed as capital gainsrather than employment-related income. On exercise the Company also receives Corporation Tax Relief on the benefit passing to the employees. This tax efficient plan is favourable for both companies and participants as it reduces tax from all angles.
One recent successstory of ours was a client that engaged us in 2006 and exited within their 5 year plan. The share price agreed with HMRC in respect of the initial equity awards was £6.15 per share. When the company was sold the value was £117 per share. Two key employees became millionaires overnight with the receptionist driving away in a Porsche. A 10% share pool was reserved for employees but rest assured the founders achieved their desired exit value and maybe even got more than they first imagined and sooner because the whole team was focused and interested in getting there. The key message being never think about it as giving away 10% but of keeping 90% of a number that is much bigger than the one you first thought of!
What about Non-executive directors?
Non-executives play a vital role in helping the executive team navigate a safe course of passage for their business but often non-execs get the short end of the stick when it comes to any equity rewards as they are not employees and therefore cannot participate in any of the tax advantaged approved employee share schemes. Non-executives are often provided with equity under an Unapproved Share Option Plan with gains subject to income tax. A more tax efficient solution can be found inthe Deferred Share Purchase Plan (DSPP) under which the participant contracts to purchase shares at full market value (often a low amount where a company isstill in its formative years) but pays only a small deposit (usually equivalent to the nominal value per share). Later, when the shares have increased in value they can be paid up in full and sold for profit. Whilst this is not a government approved scheme it has however been designed around the legislation such that gains fall within the capital gains tax regime and not income tax. This could represent a 22% tax saving for an additional rate taxpayer.
Over the last few years we have seen an extension of Entrepreneurs' Relief (a special targeted relief ensuring a 10% effective rate of tax on certain gains). When it was first introduced the relief applied to the first £1 million of gains, this was then extended to £2 million, then £5 million and now it applies to the first £10 million of gains. Eligibility for Entrepreneurs' Relief requires the individual to be an officer or employee of the Company, have 5% of shares carrying 5% of the votes and have held those shares for at least 12 months prior to sale. If all of these conditions are satisfied then the effective rate of tax reduces from 28% to 10% on up to £10 million of gains in a lifetime.
With all these tax breaks available to entrepreneurs and the benefits share schemes bring to growing businesses it is no wonder why 2012 has been hailed the year of the entrepreneur! If you would like more information please speak to one of our advisers on 020 8949 5522.