Don’t worry about a low share valuation in relation to an EMI option scheme, which is made solely for agreeing the EMI valuation with HMRC for EMI option purposes. As a business owner, you are probably used to arguing for as high a valuation as possible for your company. A higher valuation will mean that the sale proceeds are higher, or there is less dilution when you raise money by issuing new shares.
For EMI options though, a lower valuation is better for the company as it will act as a greater incentive for employees. A lower valuation will allow the price that the shares are bought at using the EMI option (ie the exercise price) to be set at a correspondingly low price. This is important as the employees’ potential gains with the EMI option are higher if the exercise price is lower. The profit being the difference between the price that the shares obtained on exercise of EMI options are sold and the exercise price of the EMI options, which is then given the tax breaks under the EMI option scheme. See ‘What are the tax advantages of EMI?’
An HMRC agreed EMI valuation is only used for the purposes of issuing EMI options to employees in a tax efficient manner under the EMI option scheme. It is a private valuation for the EMI option scheme and should have no bearing on future discussions that the company may have with others regarding the valuation of the company as a whole.
When are EMI valuations needed?
You’ll want to do an EMI valuation before granting EMI options to make sure there is no disagreement with HMRC as to tax treatment of the EMI options later on.
You may also want to repeat an EMI valuation when your employee exercises an EMI option, if there was a disqualifying event (such as an employee leaving) between the grant and exercise of the EMI option.
What we need to carry out an EMI valuation
When applying for an EMI valuation, HMRC require a VAL231 form. We’ll complete this form and submit it to HMRC for you. In addition to our EMI valuation report, HMRC require various information to accompany the VAL231 form.
Although the EMI valuation can become involved, we’ll try to make the process as simple as possible for you and to keep our information requests to a minimum. Although we may ask for more, the initial information request (which also includes the information that has to be provided to HMRC), will include the following, all of which we think should be easy for you to provide:
- any background information that will help us understand the nature of the company’s trade and circumstances
- accounts for the last three years, but if the company has been trading for less than 3 years, then just what’s available
- the most recent management accounts (if available) which should not be older than 2 months, and if the company has had a recent investment round, the balance sheet should be from after that round
- financial forecasts (if any)
- capitalisation table (if available)
- previous valuation reports (if any).
Also any details of the following:
- shares allotted and transactions in the shares since the date of the last accounts
- dividends paid or declared after the date of the last accounts
- changes to the capital structure that are completed or actively contemplated
- discussions that there have been regarding a sale of the company or an IPO.
If you have questions about any of these in the context of the EMI valuation, please do ask us.
How we carry out an EMI valuation
We use the information provided by you to calculate the EMI valuation using what we believe is the most appropriate methodology given the nature of your business, the industry, your operating history, and taking into account whether there are assets, revenues and/or profits.
Before applying any multiples we make any adjustments that we feel are relevant for items that are non-recurring, don’t relate to the business, or are not on an arms’ length basis. We then apply an appropriate multiple from a review of similar companies and/or transactions in the sector.
As stated above though, an EMI valuation may have differences to other valuation methodologies, and in accordance with HMRC guidance we will also look at relevant transactions in the shares. HMRC state that “there is often no better indication of value than actual transactions involving the same or similar asset. When considering the open market value of the company’s shares, the valuer should first ascertain whether there have been any recent transactions in those shares”. For example, if a company has recently received funding from third parties, then the EMI valuation will be derived from that transaction.
A discount is then usually applied to either of those valuations to get the EMI valuation. The discount can be large (say 75%) as the EMI valuation relates to only a small proportion of the shares in the company (usually 5 to 20%). The discount can be justified as the small proportion of shares will have very little influence or control over the company, and there may be restrictions on transfer. In contrast to external investors, employee shareholders will not have SEIS/EIS tax reliefs, board representation, veto rights nor warranty protection. We will negotiate the discount on your behalf with HMRC.
Example: If the business continues to develop as expected, the sale price of the company to the ‘right trade buyer’ could be £4 million
The valuation methodology values the company now at £2 million.
75% minority shareholding discount is applied to obtain an EMI valuation of £0.5 million.
How long does an EMI valuation take?
We’ll work out the EMI valuation, agree it with you and then apply to HMRC for agreement of that valuation. In most circumstances this process will take less than one week, but could be much quicker. HMRC normally take 3 weeks to reply. We’ll liaise with HMRC for you on the EMI valuation, and handle any negotiations with them so you don’t have to.
When does an EMI valuation expire?
Once approved by HMRC, the EMI valuation is valid for for a period of 90 days or until a significant event occurs. The EMI options should be issued during this period.
Significant events include:
- change in the share or loan capital of the company
- arm’s length transaction involving shares of the company
- negotiations or preparations for an IPO or acquisition
- declaration of a dividend on any class of shares in the company
- publication of new financial information such as annual accounts.
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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.