Equity vs Cash Compensation Structures

For a growing UK business, the decision to pay a senior hire partly in equity rather than entirely in cash is one of the more consequential structuring choices it makes. Done well, it aligns a key person with the outcome and conserves cash at the point cash is scarcest. Done carelessly, it dilutes the founders, creates a tax charge nobody budgeted for, and delivers none of the retention it was intended to buy.

This guide covers how equity compensation actually works in the UK, what each structure costs, and when cash is the better answer.

The UK Share Scheme Landscape

EMI — Enterprise Management Incentive

The EMI scheme is the reason UK equity compensation works, and it should be the starting point for any qualifying company. Options granted at or above market value agreed with HMRC attract no income tax and no National Insurance on exercise. Gains are taxed as capital rather than income when the shares are sold.

There is a further advantage that is frequently missed. Business Asset Disposal Relief ordinarily requires a 5% shareholding, which almost no employee holds. For EMI shares that requirement is relaxed — relief can apply provided the option was granted at least two years before disposal, even where the company is not the holder’s personal company.

EMI has conditions on company size, trading activity, employee working time and excluded sectors. Our EMI scheme guide covers these; the key point for structuring is to establish qualification early, since the alternatives are materially less attractive.

CSOP — Company Share Option Plan

The fallback where EMI is unavailable — typically because the company is too large, operates in an excluded sector, or the individual does not meet the working time requirement. CSOP offers favourable treatment within its own limits, though less generous than EMI.

Unapproved options

Where no tax-advantaged scheme applies. The difference between market value and exercise price is charged to income tax and National Insurance as employment income at exercise — and where the shares are readily convertible assets, that is collected through PAYE, with employer’s NIC payable by the company. This is a substantially worse outcome for both parties and frequently comes as a surprise.

Growth shares

A separate route, often used where EMI is unavailable or where the intention is to share only future value. A new class of shares participates only in value above a defined hurdle, so its value at issue is low. Structured properly with appropriate valuation, this can be tax-efficient, but it requires careful drafting and a defensible valuation.

Direct share awards

Simple to describe and usually the worst option. Giving shares outright creates an immediate income tax charge on their value, payable by an employee who has received no cash. Where shares are restricted, a section 431 election within 14 days can be advisable — it accelerates tax onto the unrestricted value now in exchange for capital treatment on future growth. This is a decision that needs advice at the time, not afterwards.

Tax Treatment Compared

What Equity Actually Costs the Business

Equity is frequently treated as free because no cash leaves the company. It is not free; the cost is simply deferred and paid by different people.

Dilution

Every share issued reduces existing holders proportionally. A 2% grant to a senior hire is 2% of every future exit, paid by the founders and existing investors. On a business that eventually sells for £20m, that is £400,000 — considerably more than the salary discount it substituted for.

The option pool comes out of the founders

In a funding round, investors typically require the option pool to be established or topped up pre-money, which means the dilution falls on existing shareholders rather than the incoming investor. Founders regularly discover this at term sheet stage rather than when planning grants.

Employer’s National Insurance

On unapproved options over readily convertible assets, the company bears employer’s NIC on the gain at exercise. For a substantial gain this is a real cash cost arriving at an unpredictable time. It can sometimes be transferred to the employee by agreement, which reduces the value of what you have granted.

Administration and valuation

Scheme establishment, HMRC valuation agreement, annual returns, and legal drafting all carry cost. Modest relative to the amounts involved, but not nil, and worth budgeting.

When Equity Is the Right Answer

• Cash is genuinely constrained and the alternative is not hiring at all.
• There is a plausible exit within a timeframe the individual finds credible. Equity in a business with no realistic liquidity event is not compensation.
• The hire can materially affect the outcome. Equity makes most sense for people whose work moves the valuation — which is the argument for weighting it towards senior appointments rather than spreading it thinly.
• The company qualifies for EMI. The tax difference is large enough that qualification substantially changes the calculation.

When Cash Is the Right Answer

• The candidate needs certainty. Someone with a mortgage and school fees will discount equity heavily, and a package that only works if the equity pays is not an attractive offer.
• No realistic exit. Profitable owner-managed businesses with no intention to sell should generally pay cash and use bonuses tied to profit for alignment.
• The role is time-bound. Interim and fractional appointments rarely suit equity, since vesting periods outlast the engagement.
• You cannot explain it clearly. Equity a candidate does not understand generates no motivation and no retention — it is dilution purchased for nothing.

Structuring It So It Works

Get EMI qualification checked early

Before offering anything. If the company qualifies, use it. If it does not, know that before you make promises, because the alternatives change what the package is worth.

Agree valuation with HMRC

For EMI, an agreed valuation underpins the tax treatment. Granting at an unrealistically low exercise price without agreement invites challenge and can undo the advantage entirely.

Four years with a one-year cliff remains standard

Departing from convention without good reason creates friction in negotiation. Where a shorter period is warranted — a deliberately time-limited appointment — say so explicitly rather than leaving it implied.

Draft the leaver provisions carefully

Good leaver and bad leaver definitions, and the post-termination exercise window, determine whether vested options are realisable or theoretical. A 90-day window requiring an employee to fund the exercise price for unsaleable shares is common and frequently means the equity delivers nothing.

Show the candidate the actual numbers

Percentage on a fully diluted basis, current share count, exercise price, valuation at last round, and what sits ahead of ordinary shares in a liquidation. Candidates who are given this take the equity more seriously; those given a percentage and nothing else discount it to near zero, which wastes the dilution.

Take advice before granting, not after

Share scheme errors are expensive and frequently irreversible — a missed section 431 election, a grant outside EMI conditions, a valuation that cannot be defended. The professional cost of getting it right is small against the cost of unwinding it.

Frequently Asked Questions

What is the best share scheme for a UK startup?

EMI, for any company that qualifies. There is no income tax or National Insurance on exercise where options are granted at an agreed market value, gains are taxed as capital, and Business Asset Disposal Relief can apply without the usual 5% shareholding requirement provided the option was granted at least two years before disposal.

Do ISOs and RSUs apply in the UK?

ISOs and NSOs are US instruments with no UK application, and the Alternative Minimum Tax does not exist here. RSUs do appear in UK subsidiaries of US groups and are taxed as employment income on vesting — they are not options, and the treatment differs accordingly.

How much equity should we offer a senior hire?

It depends on stage, the size of the option pool and how much the role can influence the outcome. Senior early appointments typically receive a low single-digit percentage; later hires considerably less. The more useful discipline is calculating what the grant is worth at a realistic exit and asking whether that justifies the dilution.

Is equity cheaper than paying cash?

Not cheaper — deferred, and paid by shareholders rather than the company. A 2% grant on a business that sells for £20m costs existing holders £400,000. It conserves cash when cash is scarce, which is a genuine benefit, but it is not free.

Should interim and fractional appointments include equity?

Rarely. Vesting periods generally outlast the engagement, and the point of these arrangements is defined, time-bound input. Day rates are the appropriate mechanism, with a completion bonus where an outcome-linked incentive is wanted.

What happens to options when someone leaves?

It depends on the scheme rules. Unvested options normally lapse, and vested options must usually be exercised within a limited window — often around 90 days — requiring the individual to fund the exercise price for shares they may not be able to sell. These provisions deserve as much attention as the headline percentage.

References & Further Reading

• GOV.UK — Tax and employee share schemes
• GOV.UK — Enterprise Management Incentives (EMI)
• GOV.UK — Capital Gains Tax rates
• ICAEW — Tax resources

General information on UK share schemes and compensation structuring, not tax or legal advice. Scheme qualification, valuation and elections depend on specific facts and are time-sensitive — take professional advice before granting equity. Tax rates stated are for the 2026/27 UK tax year and correct at the time of writing.

Adrian Lawrence FCA

Founder & Managing Director, FD Capital

Adrian Lawrence FCA is the founder of FD Capital and a Fellow of the Institute of Chartered Accountants in England and Wales (ICAEW). He holds a BSc from Queen Mary College, University of London, and has over 25 years of experience as a Chartered Accountant and finance leader working with private, PE-backed and owner-managed businesses across the UK. He founded FD Capital in 2018 to connect growing businesses with the Finance Directors and CFOs they need to scale — and personally interviews candidates for senior finance appointments.

→ View Adrian’s ICAEW profile