Startup Employee Equity Plans: EMI, ISO & Implementation

For early-stage companies, competing for talent with limited cash is a primary challenge. This guide explains how to design and implement startup employee equity plans, covering option pools, vesting schedules, and the key differences between UK (EMI) and US (ISO) schemes to help you attract and retain a skilled team.

Core Concepts: Option Pools, Vesting, and Cap Table Management

Before granting options, you need to establish the foundational structure. These initial decisions will shape your company's ownership for years, so it's important to approach them methodically. The process begins with creating an option pool, which reserves the equity you will use for recruitment and retention.

Option Pool: A reservation of a percentage of your company’s equity set aside specifically for future employees, advisors, and directors.

Sizing your option pool involves balancing investor expectations with your operational needs. A top-down view is often driven by VCs, who typically expect a 10-15% pool as part of a funding round. A bottom-up approach is based on your hiring plan for the next 12-18 months. Our guide to sizing your share option pool can help you model this. For instance, a SaaS startup might find a VC expects a 10% pool, but its hiring plan only justifies 7%. A pragmatic solution is often to create an 8% pool, building in a small buffer without diluting founders unnecessarily. This exercise reinforces the need for proper cap table hygiene from day one.

Once the pool is established, you must define how employees earn their options through a vesting schedule. The market standard is a four-year vesting period with a one-year cliff. An employee receives no options until their first anniversary, at which point 25% of their grant vests. The remaining 75% then vests in equal monthly or quarterly installments over the next three years. The cliff protects the company from granting equity to a hire who does not work out. You can find more detail in our guide to share option vesting schedules.

Another component is the acceleration trigger, which determines what happens to unvested options in an acquisition. There are two main types:

• Single-trigger acceleration: Unvested options vest immediately upon a sale of the company.
• Double-trigger acceleration: Requires two events: the company's sale and the termination of the employee’s role by the acquiring company.

Double-trigger is now standard because it protects the employee if they lose their job post-acquisition while also incentivizing them to stay, which is often a condition for the acquirer. You can explore this further in our analysis of accelerated vesting and exit triggers.

Finally, every option grant has a financial impact that must be recorded for audits and due diligence. When you record the cost of options in your financial statements, follow the IFRS guidance on share-based payment accounting (IFRS 2). The specific treatments are covered in our guide to Stock Option Accounting.

Choosing a Scheme: UK vs. US Equity Plans

After establishing the core concepts, you must select the legal structure for your share option scheme. This decision has significant tax implications for your company and your employees. The primary choice is between a government-approved, tax-advantaged scheme and a more flexible, non-qualified one. Your geography, company size, and who you are incentivizing will guide your decision.

For UK Startups

For most qualifying small and medium-sized enterprises in the UK, the Enterprise Management Incentive (EMI) scheme is the most common and tax-efficient option. Its popularity stems from its tax benefits for employees, where growth in share value is typically subject to Capital Gains Tax rather than higher rates of Income Tax and National Insurance. Our comprehensive UK EMI Scheme Setup Guide walks through the implementation process.

However, EMI has specific eligibility rules. Your company might be too large, operate in an excluded industry, or you may want to grant options to a non-employee. In these cases, you will need alternatives. You may find yourself weighing EMI vs. Growth Shares, as Growth Shares can be a useful option for senior management. When a company or individual does not qualify for a tax-advantaged scheme, the default is an unapproved scheme. Our guide provides a full breakdown of unapproved share options in the UK. For example, a UK e-commerce business with 25 employees could use EMI for its core team but would need Unapproved Options for an advisor based in Germany.

Other schemes are designed for different purposes. A Share Incentive Plan (SIP) might be more appropriate if you want to offer equity to your entire workforce, and it is worth understanding the difference between SIPs and EMI. In other situations, you might want to avoid issuing equity altogether. Here, Phantom Share Schemes offer a cash bonus tied to company value without diluting ownership. Finally, granting equity to advisors has specific considerations, detailed in our guide on advisor equity compensation.

For US Startups

In the United States, the primary decision for founders is choosing between Incentive Stock Options (ISOs) and Non-qualified Stock Options (NSOs). The fundamental difference lies in their tax treatment, which impacts both the employee and the company.

Incentive Stock Options (ISOs) are generally preferred by employees due to their tax advantages. With an ISO, an employee typically pays no tax at grant or exercise. Tax is only due when the shares are sold. If they hold the shares for at least two years from the grant date and one year from the exercise date, the gain is taxed at the more favorable long-term capital gains rate. This makes ISOs a powerful tool for attracting full-time talent, but the company does not get a tax deduction for them.

Non-qualified Stock Options (NSOs) are more flexible and can be granted to anyone, including employees, directors, and consultants. For the recipient, tax is due at exercise on the “bargain element.” This amount is taxed as ordinary income. While less tax-efficient for the recipient, NSOs provide a key benefit to the company: it can claim a tax deduction equal to the income the employee recognizes. For example, a US Biotech startup would typically grant tax-advantaged ISOs to its scientists but use flexible NSOs for consultants on its advisory board. For a deeper dive, consult our guide to US stock option plans.

Bargain Element: The difference between the Fair Market Value (FMV) of a share and the lower exercise price paid by the employee.

Implementation: Valuation, Legal Setup, and Compliance

Choosing your scheme is a major step, but turning that decision into a legally sound reality requires careful execution. This implementation phase involves formal valuations, legal documentation, and ongoing administration. Errors at this stage can lead to tax penalties and undermine the value you are trying to create.

Valuation is central to implementation. You cannot simply invent an exercise price; it must be based on the Fair Market Value (FMV) of your company’s common stock at the time of the grant. A price set too low can trigger adverse tax consequences. In the US, startups must obtain a formal valuation from an independent appraiser. For US startups, specialist guidance on 409A valuations is available from valuation teams at firms such as KPMG. This valuation provides a safe harbor with the IRS and is detailed in our guide to 409A Valuations for US startups.

In the UK, the process for tax-advantaged schemes involves pre-agreement with His Majesty's Revenue and Customs (HMRC). For an EMI scheme, you must agree on a valuation with HMRC before granting options. This involves submitting a detailed valuation report. To agree a valuation for an EMI grant you can use HMRC’s VAL231 process to request a formal check. Once HMRC agrees, that price is locked in for your option grants. This step is detailed in our HMRC Share Valuation for EMI guide.

With a defensible valuation, the next step is legal and administrative setup. This involves creating the scheme's foundational documents: a formal 'Scheme Rules' document and individual 'Option Agreements' for each grant. These documents must be approved by your company's board and recorded in board minutes. Formalizing these procedures is a key part of your company's governance and should be reflected in your Accounting Policy.

A share option scheme is not a 'set it and forget it' instrument. It requires ongoing administration to maintain its legal and tax-advantaged status. You must keep meticulous records of all grants, exercises, and cancellations. Tax authorities also require regular reporting. For UK companies with an EMI scheme, this means filing an annual return with HMRC. Failing to meet deadlines can jeopardize the tax benefits for all participants, as outlined in our guide to EMI reporting requirements.

Managing Your Equity Plan: Communication and Scaling

Launching your scheme is a significant milestone, but its success depends on what happens next. A plan that is not understood will not be valued. Your initial plan must also be able to evolve as your company raises capital and grows its team.

The value of equity is lost if your team members see it as a complex, abstract concept. You must invest time in making it tangible. This means clearly explaining what an option is, how vesting works, and the potential financial upside in an exit scenario. It is important to do this without giving financial advice, which creates legal risks. Instead, focus on providing clear, factual information. Our guide on employee share scheme communications provides compliant frameworks for this.

As your startup grows, your hiring needs will likely outpace the options in your initial pool. This often becomes a key discussion during your next funding round. New investors will want to ensure there is enough equity to hire the senior talent needed for the next phase of growth. This often requires expanding the option pool, which dilutes all existing shareholders. For example, ahead of a Series A, a founder might model why the 2% remaining in the pool is insufficient to hire three senior roles. This process is detailed in our guide on Series A option pool planning.

Finally, consider how to keep long-term, high-performing employees motivated after their initial grants have fully vested. To address this, many companies issue additional 'refresher' grants to key employees. These new grants typically vest over a shorter period and are priced at the current Fair Market Value, ensuring your most valuable team members remain aligned with the company’s future success.

Frequently Asked Questions

Q: How much equity should a startup's first employee receive?

A: This depends on their role, experience, and the company's stage. A senior engineer joining at the pre-seed stage might receive 0.5% to 2.0%, while a more junior hire would be lower. The grant should reflect the trade-off between a lower cash salary and the equity's potential upside.

Q: What is the main difference between UK EMI and US ISO schemes?

A: Both offer tax advantages to employees, typically taxing gains as capital gains rather than income. The key differences are the specific qualification rules for the company and employees, and the tax deduction treatment for the company. US companies get no deduction for ISOs, whereas UK companies often can for EMI.