The different types of EMI options are based on one or a combination of the following principles.
Exit-only EMI options
Many EMI options are exit only. This means that employees can only exercise the EMI option on an ‘exit event’ such as the business being sold or an IPO. Employees can usually exercise their EMI options without having the cash to pay the exercise price (this is called ‘cashless exercise’) as:
- on a business sale, the exercise price for the EMI options is paid from the sale proceeds, with employees receiving the net cash amount
- on an IPO, the exercise price for the EMI options is paid by selling a portion of the employees’ shares, with employees keeping the rest of their shares.
Jargon
‘Grant’ refers to the award of an EMI option.
‘Vesting’ refers to a right to buy a particular number of shares under the EMI option.
‘Exercise’ refers to the employee buying the option shares by paying the exercise price under the EMI option.
Time-based EMI options
Time-based EMI options can mean either:
- the number of shares that can be bought by exercising an EMI option increases over time (say, additional 10 shares each year for three years); or
- the EMI option can be exercised after a particular time has elapsed (say, after five years).
Performance-based EMI options
Performance-based EMI options can mean either:
- the number of shares that can be bought by exercising an EMI option increases if a particular performance target is met (say, the company achieves a particular revenue target); or
- the EMI option can be exercised if a particular performance target is met (say, if the business has achieved an agreed valuation).
Common examples:
| Exit only – this type of EMI option is useful if you are working towards selling your company and you want to motivate your employees by aligning them to that goal | |
| The EMI option entitles an employee to an agreed number of shares. The shares can be bought by exercising the EMI option on an exit occurring at any time over the next ten years. Employees generally don’t need cash to buy the shares under the EMI option as the exercise price for the EMI option can be paid out of the sale proceeds. | |
| Vesting: | All the shares are vested at grant of the EMI option |
| Exercise: | EMI option can be exercised to buy the vested shares on an exit |
C
| Exit, four year vest, one year cliff – this is similar to the exit only EMI option above and is often used by tech companies | |
| A ‘cliff’ is the time that must pass after the grant of the EMI option before employees are entitled to any shares. Employees leaving in the first year get nothing, but after that they become entitled to a pre-agreed number of shares for a particular EMI option spread over the next three years. The shares can be bought by exercising the EMI option on an exit occurring in the next ten years. Employees generally don’t need cash to buy the shares under the EMI option as the exercise price can be paid out of the sale proceeds. | |
| Vesting: | Shares vest over four years as follows: no shares vest in the first year after grant of the EMI option (this is the ‘one year cliff’) 25% of the shares vest on the first anniversary of the grant date of the EMI option; and the balance of the shares vest on an equal monthly basis over the next three years. |
| Exercise: | EMI option can be exercised to buy the vested shares on an exit |
| Three year vest – this type of EMI option can be used if you want to give equity in a tax efficient way. | |
| The EMI option entitles an employee to a pre-agreed number of shares spread over the next three years. The shares can be bought by exercising the EMI option at any time in the next ten years. Employees will need cash to buy the shares under the EMI option. Founders will need to be comfortable with employees owning shares in the company, which are usually bought back if employees subsequently leave the company. | |
| Vesting: | One third of the shares vest on the first, second and third anniversaries of the grant date of the EMI option |
| Exercise: | EMI option can be exercised to buy the vested shares at any time |
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Please Note: This article contains general information only and Simply Equity is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. This article is not a substitute for professional advice and should not be used as such. Simply Equity does not assume any liability for reliance on the information provided in this article.