Employee options in M&A transactions
How will the exercise price be funded?
Employee options often play a key
role in M&A transactions and need
to be considered by all parties.
What are the key issues to be aware of?
• Which options will be exercised as part of the
deal?
• How will the exercise price be funded?
• Tax pitfalls and opportunities
Which options will be exercised?
When a company merges with or is acquired by
another company, employees with share options
usually get to exercise all their options, otherwise
known as ‘full vesting’. However, there are some
exceptions to this. For example, if employees have not
worked for the required time or if certain performance
targets have not been met by the time of the deal, they
might not be able to exercise their options in full.
Before the deal, it’s essential to review if any
unexercised options will become fully vested. Some
options contain ‘accelerated vesting’ clauses,
whereby any outstanding performance or time-based
vesting targets are automatically waived if an exit
occurs.
If the decision to waive these targets depends on the
directors’ discretion, care must be taken. This can have
adverse implications for tax-advantaged options,
such as Enterprise Management Incentives (EMI)
and Company Share Option Plans (CSOP), where
applying director discretion to accelerate vesting
can cause a loss of tax-advantaged status, resulting
in PAYE and National Insurance contribution (NIC)
charges.
Where the exercise price represents a material cost to the
option holders, thought needs to be given to its funding.
If the payment is pure cash, the exercise price, along
with any PAYE/NIC, can typically be withheld from sale
proceeds.
However, if the payment includes non-cash elements, such
as shares, loan notes or earn-out rights, it can become
complicated when withholding such amounts from the gross
sales proceeds. In some cases, the cash consideration is
not sufficient to cover the exercise price and PAYE/NIC
liabilities. Therefore, it is often necessary to adjust the split
of cash to non-cash consideration, for option holders to
receive more cash. Where a deal includes substantial
non-cash consideration, an early analysis of the net cash
impact on option holders is recommended – especially for
those holding unapproved options – to identify those cases
where there is a cash ‘gap’.
Tax pitfalls
The immediate tax issue to consider is whether the
exercise of an option creates PAYE/NIC charges. Whilst
tax-advantaged options, such as EMI and CSOP, can
potentially remove these liabilities, they can still be subject
to PAYE/NIC in certain scenarios, such as:
• EMI options granted at undervalue
• EMI options subject to a disqualifying event (such as
for a leaver who retains their options)
• CSOP options exercised within three years of grant
A penal tax regime applies where PAYE is not correctly
accounted for or recovered from the employee within the
required time limits.
A review of employee options will typically be the focus of
legal and tax due diligence, with appropriate warranties
and indemnities then provided by the sellers.
Tax opportunities How haysmacintyre can help
Where conditions for Income Tax relief are met, EMI and Our Share Schemes team has extensive experience
CSOP options can provide employees with exit proceeds advising from a buyer or seller’s perspective and can
at Capital Gains Tax rates at 20%, or even 10%, in the help with:
case of EMI options held for two years or more.
• Sale readiness and vendor due diligence
Additionally, the exercise of employee options typically • Buyer financial and tax due diligence
results in a Corporation Tax deduction for the employer
• Financial modelling
company. This deduction is based on the market value
of the shares when the options are exercised, less • Tax planning for individual and corporate sellers
the exercise price paid, and is due even where the • Post-deal tax compliance for employers and sellers
employees’ gains are not subject to Income Tax.
For further assistance, get in touch with a member of our
Where sizeable Corporation Tax deductions are due, the team.
sellers may seek to negotiate with the buyer so that any
resulting tax saving leads to additional sale proceeds
being paid to them. In other words, the sellers may seek
to benefit from the tax advantages by increasing the
amount they receive from the sale. This negotiation would
be a way for the sellers to capture some of the financial
benefits that arise from the favourable tax treatment of the
transaction.
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Contact

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Partner
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E icliffe@haysmacintyre.com

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