Why CSOPs are worth revisiting

What is a CSOP? 

 The Company Share Option Plan (‘CSOP’) is a long-standing tax-advantaged share option arrangement designed to help companies incentivise, reward, and retain employees and directors through equity participation.  

Although CSOPs have been around since 1984, they have often been overshadowed by the Enterprise Management Incentives (EMI) option scheme. The EMI scheme was introduced in 2000, and offers more generous tax advantages and greater flexibility for smaller qualifying companies. As a result, EMI is usually the default choice for SMEs that meet the relevant eligibility criteria. However, the relevance of CSOP has grown in recent years.

This is particularly true following the 2023 changes to the CSOP legislation which relaxed certain requirements and increased the value of awards which can be made under CSOP. These changes have made CSOP a far more practical and attractive option for companies that do not qualify for EMI. 

For many companies, CSOP can still be a strong and tax-efficient way to reward key employees. It also helps align their interests with long-term business success.

This blog explores the benefits and challenges of using a CSOP and considers why it continues to be a valuable tool in the employer incentive toolkit. 

The benefits of CSOP

Minimal risk for employees

CSOP is a type of share option plan. It gives an employee the right (but not the obligation) to buy shares at a specified price in the future. A company can grant a CSOP option with an exercise price set at the shares’ current market value and the employee can choose whether to exercise the option at a later point. If the share price has risen when the employee is able to exercise the option (i.e. buy the shares), the employee can acquire the shares for a favourable price. If the price has fallen or remained flat, the employee can simply allow the option to lapse, with no downside. 

Favourable tax treatment

One of the main attractions of CSOP is the favourable tax position for employees. Provided the relevant statutory conditions are met, there is ordinarily no income tax or national insurance contributions (NICs) on the grant or exercise of a CSOP option. Instead, any gain is typically subject only to capital gains tax (CGT) when the shares are sold.

With the main rate of CGT on shares currently at 24%, this is usually far more favourable than a cash  bonus or unapproved share options. Those are treated as income and taxed at higher rates of 40% or 45% for higher and additional rate taxpayers.

From the company’s perspective, CSOPs can also be tax efficient. The company can usually obtain a corporation tax deduction broadly equal to the employee’s taxable gain on exercise. In addition, the cost of implementing a CSOP are ordinarily deductible for corporation tax purposes.

Low cost for company

A CSOP does not require the company to pay cash to employees when the options are granted. In fact, save for limited examples (e.g. the company buys back the shares) a CSOP plan should not lead to the company needing to pay the employees anything. The employee will receive the benefit when they sell the shares, often as part of a sale to a third party.

While there are upfront professional costs associated with designing and implementing the plan, ongoing costs are considered modest. Therefore, compared to a bonus arrangement (where significant cash outlays may be required) a CSOP can be viewed as being low cost – this makes CSOPs particularly attractive where cash preservation is important.

Flexible

Although CSOPs are subject to statutory requirements, companies retain considerable flexibility in how they design and operate their plans. For example, employers can:

• Choose which employees receive options (there is no requirement to offer the plan
  company-wide)
• Determine the number of options granted to each participant, subject to the statutory limits
• Include performance-based conditions linked to company or personal objectives
• Apply time-based vesting schedules to support retention

This flexibility allows companies to target CSOP awards at key employees whose performance and retention are critical to the business’s growth.

Relaxed requirements compared to EMI

CSOPs are often the preferred alternative where EMI is not available. EMI has strict qualifying
requirements, which a company may not meet. At the date of grant, the company (or group) must, among other things:

• Have gross assets of no more than £120 million
• Have fewer than 500 full-time employees
• Not carry on certain “excluded activities” to a substantial extent (such as property development or operating hotels).

Furthermore, EMI options can only be granted to employees and directors which meet certain minimum working time requirements, meaning part-time employees may not qualify.

CSOP, by contrast:

• Has no company size limit
• There is no restriction on the number of employees a company can have
• Does not put restrictions on trading activities of companies
• Has no requirement in relation to an employee working hours (although directors must work a minimum of 25 hours per week, excluding meal breaks)

Historically, CSOPs were subject to strict rules on the types of shares over which options could be granted. However, following reforms introduced in 2023, CSOP options can now be granted over a much wider range of share classes. This relaxation has significantly increased the accessibility of CSOPs, particularly for companies with private equity ownership, multiple share classes, or complex historic investment structures. Since these changes, we have seen an increase in the number of our clients awarding CSOP options to employees.

Why CSOPs are suitable for SMEs

Although CSOPs are not exclusively for SMEs, they are particularly attractive to smaller businesses. They offer a tax-advantaged incentive without the heavy administrative burden associated with some tax advantaged share plans, such as Save as You Earn (SAYE) and a Share Incentive Plan (SIP).

Like EMI, CSOPs require annual reporting to HMRC and the preparation of suitable option documentation. The regime is well established and can be operated successfully by companies without large internal HR or legal teams.

CSOPs have been in place for many years and are a familiar, HMRC-approved plan. As a result, the tax treatment and outcomes are well understood by HMRC, advisers and investors. This gives companies a high degree of comfort and certainty when implementing and operating a CSOP. HMRC data here suggests that in the 23/24 tax year 350 companies granted CSOP options.

The challenges of CSOP

Limit on value

One of the main limitations of CSOPs is the statutory limit on the value of options that can be granted to an individual. Each employee or director may only be granted CSOP options over shares with an unrestricted market value of up to £60,000 at the date of grant. While this limit was doubled from £30,000 in 2023, it may still constrain the ability to deliver significant equity participation to senior executives or key employees.

It is worth noting:

• The £60,000 limit is set by reference to the share value at the date of grant. In a growing company, the value of the shares at the time the options are exercised may be significantly
  higher, allowing employees to benefit from substantial growth despite the initial limit on value.
• CSOP options are typically granted over minority interests in private companies.
  When valuing minority shareholdings in private companies, a minority interest discount will
  often apply, reducing the value attributed to the shares at grant. On a subsequent sale of the company, such as a whole company exit, this discount would not apply, potentially resulting in a meaningful uplift in value for the employee.

Minimum exercise period (typically three years)

To benefit from the favourable tax treatment, CSOP options ordinarily cannot be exercised until at least three years after the date of grant, except in limited circumstances (such as certain ‘good leaver’ events or a takeover). This long holding period helps promote retention, but may reduce the incentive’s immediate perceived value for employees expecting shorter-term rewards.

No discounts at grant

CSOP options must be granted with an exercise price that is at least equal to the ‘tax market value’ of the underlying shares at the grant date. CSOPs do not permit discounted exercise prices.

For tax purposes, the ‘market value’ will be based on the price that the underlying shares might reasonably achieve if sold on the open market. . For many illiquid private companies, this value will factor in a ‘minority interest discount’ to reflect the lack of control a small shareholding would confer.

However, this discount wouldn’t apply in a full company sale, where all shares are sold together. This means CSOPs can offer significant upside for participants if the company is later sold.

As CSOP is a tax-advantaged plan, it is possible to agree the share valuation with HMRC in advance of granting the options. Companies looking to grant CSOP options should secure a valuation agreement with HMRC. Buyers will often look for this on a future due diligence exercise.

UK-specific plan

CSOP provides tax advantages to UK tax resident participants. However, CSOP may not provide any advantages to employees who are tax resident in other jurisdictions. This can make CSOP less suitable for businesses with large international workforces. Employers with global teams may therefore need complementary plans to ensure equity awards provide the desired incentive across jurisdictions.

Limited attractiveness for employees unfamiliar with equity

For employees who are unfamiliar with equity incentives, share options can be harder to understand than straightforward cash bonuses. Concepts such as vesting, exercise prices, dilution and exit conditions may require careful explanation. Without clear communication, employees may undervalue CSOP awards or fail to fully appreciate their potential upside. For some employees, a simple cash bonus may be more motivating.

Liquidity event needed to sell

Even where a participant has satisfied the relevant holding period, exercised their option and acquired shares, there may still be no immediate opportunity to realise a gain. In many private companies, there is no readily available market in which to sell shares acquired on the exercise of CSOP options. As a result, employees will often only be able to convert their equity into cash on a liquidity event, such as a sale of the company.

This lack of liquidity can reduce the practical attractiveness of CSOPs, particularly for employees who are unwilling or unable to wait for an exit event.

CSOP options are frequently granted with an exit in mind. It is common for the plan rules to allow options to be exercised on a sale of the company, with the resulting shares sold immediately as part of the transaction. In those circumstances, the participant can realise value at the same time as other shareholders. This helps reduce the liquidity risk of holding shares in a private company.

How we can help

When implemented correctly, a CSOP can be a powerful tool for employee incentivisation.

Our share plan team has extensive experience in designing and implementing CSOPs for companies at all stages of growth. We support clients throughout the end-to-end process, ensuring that all legislative requirements are met and that each CSOP is structured to deliver your specific commercial objectives.

• Eligibility assessment: confirming whether the company and proposed participants meet the relevant CSOP requirements
• Plan design: tailoring the structure of your CSOP to align with your reward strategy, growth plans, and retention objectives
• Share valuation: agreeing an appropriate CSOP share valuation with HMRC
• Documentation: drafting plan rules, option agreements and supporting documentation
• Employee communications: helping employees understand the value of their awards and maximise engagement and incentivisation
• HMRC compliance: assisting with registering the scheme with HMRC
• Ongoing support: assist you with meeting annual reporting obligations and providing advice on future option grants, exercises and exit events.

By combining technical expertise with a practical, commercial approach, we help ensure that your CSOP is both compliant and effective as a long-term incentive.