Don’t lose the sale because of the EMI Scheme valuation

October 24, 2023

We have been thinking a lot about EMI scheme valuations over the past week or so.

Occasionally, people we speak to feel that the valuation they commission for an EMI scheme doesn’t really matter all that much. I can say, from personal experience, that they can become very important very quickly. When I was selling my family business, five days before signing the SPA, the buyers’ lawyers found that when the EMI scheme was set up, a proper valuation had not been done.

They said they did not buy companies where HMRC might dispute the Scheme and threatened to walk away. You can imagine how we all felt! We sorted it, I am pleased to say, but it was not a pleasant time.

When I recount story with lawyers, many have had almost identical experiences.

So, whilst a startup may not think getting the EMI Scheme valuation is important “Surely we are a startup and there is no value?!” and they may think they can cut costs in this area, they would be wise to think hard about when the risks might actually appear.

When I met the HMRC valuations team in Nottingham recently, they made it very clear that each valuation is unique, and you cannot assume that an automated or back of the envelope valuation will satisfy them. This definitely applies in respect of EMI Scheme valuations.

It’s worth bearing in mind that a newly incorporated company could suddenly have quite a lot of value if the activities undertaken before incorporation are intrinsically valuable (e.g., creation of tangible or intangible IP) and then ownership of this activity is transferred into the company. Equally, if that new company goes onto achieve a fundraise shortly after incorporation, setting a nominal valuation for the company just weeks or even months beforehand, might, with hindsight, look a bit odd to a critic who is keen to bolster HM Treasury’s coffers.

It is important to remember that HMRC has extraordinary rights to look both forwards and backwards in time when they review things like EMI schemes. You never know if they have red flagged a situation but choose to bide their time before they launch a challenge. If a basic valuation is carried out for an EMI scheme, all parties involved are happy with it and it gets approved by HMRC, it still does not mean you are definitely in the clear. And remember HMRC can examine subsequent EMI Scheme filings, Corporation Tax Returns, VAT returns, R&D Tax credit claims and Companies House filings at the touch of a button.

Transparency with HMRC is always a good way of mitigating risks.

Many lawyers are curious about what could cause the value of a company to change quickly. Warning signs are a change in the company’s commercial trading (up or down), think winning or losing a major contract, or a fundraise (especially with a complex cap table) which resets the valuation of the shares underpinning the Scheme.

Ironically, at exit the primary issue is not HMRC but the buyer, as I found out! If there is no paperwork trial of verifiable, evidence-based and comprehensive valuations for share schemes; the buyer will challenge. The best-case scenario is that the buyer agrees to accept the situation but retains more of the sale proceeds until it is satisfied that HMRC has not challenged the valuation. The next best outcome is that the buyer chips the purchase price to get the deal done. The worst-case scenario is that the buyer walks away. Small things done ages ago can have big impacts when it matters.

Even if the deal gets done, the directors of the selling company won’t be quite off the hook for a while. HMRC may challenge at an individual employee level and the company owner will simply direct an unhappy ex- (or worse, current) employee towards the old directors.

We are very sensitive to start up company budgets on advice. It’s not unknown for us to undertake heavily discounted contracts to perform a valuation to ensure that the valuation is done correctly in line with HMRC guidelines. We would rather that than they went it alone or did not do it properly, only to regret it later on.

So do give us a buzz if you think we can help one of your clients in this area. If you would like to get in touch, you can reach me on 07736 676 212 or you can email me at modwenna.rees-mogg@athlacapitalmanagement.com.