The 25% club: Founders’ Relief and the rest of Budget 2026

Chancellor John Healey’s first Budget had little in it to make people feel better off.  For founders and investors it had one genuine headline, but with an awkward condition attached.  Founders’ Relief is a proposed new 10% rate of capital gains tax (“CGT”) on up to £10m of lifetime gains, for qualifying disposals from 6 April 2027.

Alongside it, the lifetime limit for Business Asset Disposal Relief (“BADR”) is halved, income tax relief on Venture Capital Trust (“VCT”) subscriptions stays at 20%, and the Company Share Option Plan (“CSOP”), now branded ‘EMI2’, has its individual option limit doubled.

The 25% club

A condition for Founders’ Relief is membership of the 25% club.  To qualify, a founder must have held at least 25% of the company’s ordinary share capital when it started trading, or preparing to trade.  That split is usually settled around incorporation, although founders may not be thinking then about lifetime limits.  Against BADR as it will stand from April 2027, getting into the 25% club is worth about £250,000 on a £2m gain and more than £1m on an £8m gain.

The Chancellor pitched Founders’ Relief at “the founders of our most successful firms”, and the small print takes him at his word.  HMRC’s impact note expects about 600 individuals a year, across about 400 businesses, to be eligible.  Those are numbers for a club rather than a movement.  Whether a founder qualifies will turn on decisions taken years before any sale: who held what when the company started trading, whether the company has changed what it does, and how and when it grew and by how much.  For founders outside the club, the Budget’s message is a smaller BADR.

Founders’ Relief: the proposed conditions

The relief is at consultation stage.  HM Treasury’s technical consultation closes on 30 November 2026, and the government intends to legislate through amendments to Finance Bill 2026-27.  The £10m limit applies per individual, so more than one founder can claim in respect of the same company.  It will be reduced by any BADR or Investors’ Relief claimed from 6 April 2027.

Despite the name, the relief is not only for founders.  The consultation extends it to significant early investors, and none of the individual conditions requires the claimant to be an employee or officer.  An individual who backed the company with 25% of the shares when trading, or preparation for it, began could therefore qualify.  The relief is a CGT relief for individuals, so it is not available to corporate investors.

As proposed, the individual must:

• have held at least 25% of the company’s ordinary share capital, with matching voting rights and rights to profits and to assets on a winding up, when the company’s trade, or the preparation for it, began;
• have held the shares for at least five years before the disposal; and
• have been UK resident under the statutory residence test for at least five continuous tax years before the disposal.

The company must:

• be within the charge to UK corporation tax and have had a substantial UK presence for the five accounting periods before the disposal;
• be a trading company, or the holding company of a trading group, with no substantial non-trading activities and none of the activities excluded under the Enterprise Investment Scheme (“EIS”) rules, such as dealing in land or financial services;
• still carry on the trade it was set up for, with no major change in its nature; and
• in the accounting period before the disposal, have had turnover of at least £10m and at least 15 qualifying full-time employees: people working at least 35 hours a week and paid at least the national minimum wage, but not directors, contractors or agency workers.

It must also pass two of three tests:

• Turnover: average annual compound growth of 25% over three consecutive accounting periods within the ten years before the disposal, starting from turnover of at least £10m in the accounting period before the first of the three.
• Headcount: the same 25% compound growth, measured in qualifying full-time equivalent employees, starting from at least 15 full-time employees in the accounting period before the first of the three.
• Innovation: at least £1.5m of qualifying research and development (“R&D”) expenditure on which R&D tax relief was claimed, for accounting periods ending in the three years before the disposal.

This summary follows the consultation.  HMRC’s impact note differs in three places: it says five tax years rather than five years, uses full-time equivalents for the 15-employee limb, and measures turnover and headcount in the accounting period ending in the year before the disposal.  It also does not repeat the requirement that the 25% carry matching votes and rights to profits and assets, which the consultation imposes.  The legislation will settle which is right.

Who the conditions leave out

• The later arrival. The 25% is tested once, when trading, or preparation for it, began.  That is generous to the diluted founder and unforgiving to the late one.  On our reading, later dilution does not undo the test, and the consultation proposes that the relief applies to all shares a qualifying founder disposes of, not only the original holding, provided each has been held for five years.  But a chief executive brought in at Series A with 10% does not qualify.  Nor does a co-founder who joins six months after trading, or preparation for it, began, whatever stake they take.
• The fifth co-founder. Four co-founders with 25% each, and no other shares in issue, could all qualify.  Five with 20% each could not.  Twenty-five per cent may well become a number founders think about when they divide equity at the outset, provided the shares carry the votes and economics the condition requires.  The denominator matters too.  If ‘ordinary share capital’ takes its usual meaning under section 989 of the Income Tax Act 2007, as it does for BADR, issued share capital counts unless it carries a fixed-rate dividend entitlement and no other right to participate in profits.  Shares already issued to early employees or advisors when trading, or preparation for it, begins could therefore count against the founders’ 25%, not towards it, depending on their rights rather than their labels.  If they held 10%, four founders splitting the rest equally would each hold 22.5%, and none would qualify.  An option pool of unissued shares reserved for future grants would not count, because options are not share capital until exercised.
• The pivot. The company must still carry on the trade it was established for, with no major change in its nature.  Start-ups often change what they do between incorporation and exit.  As drafted, a company that started as one business and sold as another could fail this condition however well it has done.  A new trade added alongside the original would be treated in a similar way to an excluded activity.  The consultation asks whether the company conditions work in practice, and this one deserves responses.
• The steady compounder. The growth tests are measured from scale, not from start-up.  A company that grows from £1m to £10m of turnover in three years has done nothing towards the turnover test, because the three-year window can only begin once turnover is at least £10m.  Passing it then means growing from £10m to approximately £19.53m.  A profitable business growing turnover at 15% a year and claiming no R&D relief has to pass both growth tests.  It will fail the turnover test.  The test is annual average compound growth across three consecutive accounting periods.  Whether a flat or falling year within those periods is fatal, even where the average is high enough, is not clear, and founders with uneven histories should raise it in a response.  And because the window can sit anywhere in the ten years before the sale, the evidence may predate the records a company is normally required to keep, a problem the consultation itself acknowledges.
• The offshore holding company. The company must be within the charge to UK corporation tax and have had a substantial UK presence for five accounting periods.  The consultation says references to a company include a group where appropriate, but where founders hold shares in a non-UK parent of a UK trading business, it does not yet say how those conditions apply to the parent.  How the relief treats reorganisations, including a later ‘flip’ into a new holding company, is another point the consultation asks about.  Anyone planning a flip before an exit should wait for the answer before relying on the relief.

None of this is unreasonable for a relief aimed at scale-ups.  It is simply narrower than it sounded on Budget day.

The relief also leaves a qualifying founder exposed after the sale.  If HMRC later challenges the company’s R&D claim and a condition the founder relied on turns out not to have been met, the founder loses the relief and must pay the extra tax with interest, unless, on our reading, the company still passes two of the three tests without it.  Much of the evidence will sit with a company the founder no longer controls.  The consultation proposes a statutory right for founders to obtain it from the company.  Until that exists, a founder selling shares should negotiate a contractual right to information and co-operation from the buyer after completion.

What it is worth

Take a hypothetical company whose two co-founders each held 40% when it began trading, or preparing to trade, in 2020.  They sell in June 2028, each realising a gain of £8m.  Ignoring the annual exempt amount and any losses, and assuming that both pay higher-rate tax, that today’s rates still apply, that each meets the individual Founders’ Relief conditions with the full £10m limit available, and that each would otherwise qualify for BADR with no earlier claims:

If the conditions are met, each founder pays £1.09m less than if they had failed and BADR were the best relief available.  On the same assumptions, the saving is about £250,000 on a £2m gain, £670,000 on £5m and £1.37m on £10m.  Gains above the available Founders’ Relief limit are taxed under the ordinary rules, subject to any other relief that applies.

The table also shows how little BADR will matter at this level.  After 6 April 2027 a full, unused BADR limit saves at most £30,000, under 0.4% of an £8m gain.  For a founder with a gain of that size, the comparison that matters is 10% against 24%, and access to the 10% rate depends on meeting all the qualifying conditions.  A serial founder should also note that BADR or Investors’ Relief claimed from 6 April 2027 reduces the Founders’ Relief limit.  The consultation refers to amounts claimed from that date, and HMRC’s impact note to claims made from it.  On that wording, BADR claimed in a 2026-27 return for a sale in March 2027 could still reduce the limit, so a sale shortly before 6 April 2027 should not be assumed to leave it intact until the draft clauses settle the point.

BADR halved, at 18%

For qualifying disposals on or after 6 April 2027, the BADR lifetime limit falls from £1m to £500,000 (OOTLAR, paragraph 1.33).  The rate stays at 18%, which has applied since 6 April 2026, against a main rate of 24% for higher and additional rate taxpayers.  At today’s rates, the most a full, unused limit can save therefore falls from £60,000 to £30,000.  The Chancellor said the change means “no change for 3 in 4 claimants”.  For the fourth, the halving costs up to £30,000 in extra tax.  The Budget’s own costings show the two broadly offsetting: from 2028-29 the BADR change raises between £180m and £305m a year, and the new relief costs between £180m and £300m.  The first year is different: in 2027-28 the relief is costed at £260m and the BADR change raises £60m.

The cut reaches employees too.  Shares acquired under EMI options can qualify for BADR without the usual 5% shareholding, provided, among other conditions, the option was granted at least two years before the sale.  An employee with an EMI gain above £500,000 will lose BADR on the excess, and will almost never qualify for Founders’ Relief, because they did not hold 25% when the company started trading or preparing to trade.

The £1m limit continues to apply to disposals before 6 April 2027, subject to transitional rules.  The government has said there will be special provisions for contracts entered into before that date but not completed, and for certain share reorganisations and exchanges not completed by then.  The detail has not yet been published.  Anyone with a sale that could straddle 6 April 2027 should check those provisions in the draft legislation before relying on the timing of exchange.

Mechanics of getting value out of the company to be re-worked

Founders will also need to watch reforms to how money taken out of a company is taxed.  The government will proceed with all seven proposals to modernise the taxation of distributions, with changes, from April 2028 (summary of responses), raising between £775m and £800m a year from 2029-30.  Three matter most for founders.  When a company buys back its own shares, for example to buy out a departing founder, capital treatment will depend on mechanical conditions in place of the current, largely subjective trade benefit test.  A proposed requirement to have been an employee for the two years before the sale will be relaxed, and the government still sees a 5% minimum holding as right for most transactions, although it will engage further on it.

The anti-avoidance rules on transactions in securities, which can tax as income what a shareholder receives as capital, are also being reformed.  And, as we noted in our Insight on dividends, capital reductions and buybacks, capital that can later be returned as capital after a share reorganisation will be frozen at the amount originally subscribed, which reduces the room to take value out as capital after inserting a new holding company.  That rule will apply only to reorganisations after the legislation takes effect, and listed companies are excluded.  A technical consultation, including draft legislation, is promised for 2027.  The government says it does not intend the reforms to undermine EMI, CSOP, the Enterprise Investment Scheme or the Seed Enterprise Investment Scheme.

VCT relief stays at 20%

Income tax relief on VCT subscriptions fell from 30% to 20% for shares issued from 6 April 2026, a change announced at Budget 2025.  Healey did not reverse it, and his speech did not mention the venture capital schemes at all.  VCT fundraising is in the doldrums, and nothing in this Budget changes that.

For the Seed Enterprise Investment Scheme (“SEIS”), EIS and VCTs, the Budget offers technical fixes for shares issued from 6 April 2027.  SEIS and EIS or VCT investment can be made on the same day without affecting relief.  EIS relief will survive on the part of an issue within the investment limits, instead of being lost on the whole issue.  And one investor’s late payment will not, of itself, cost the other investors their relief.

EMI2 is a bigger CSOP

The government has rebranded the CSOP as ‘Enterprise Management Incentives 2’ from 28 October 2026, although the legislation will keep the CSOP name.  From 6 April 2027 (OOTLAR, paragraph 1.6):

• the individual option limit doubles from £60,000 to £120,000. Despite the name, it keeps the CSOP rules, which work quite differently from EMI’s: options cannot be granted at a discount to market value, and tax relief generally depends on exercising the options within their tax-favoured window, currently three to ten years after grant.  Nor do shares acquired under it share EMI’s route into BADR without the usual 5% shareholding;
• the interaction between the CSOP and EMI individual limits is removed. HMRC says CSOP options will not count towards an individual’s EMI limit, so an employee could hold up to £250,000 of EMI options and £120,000 of EMI2 options at the same time;
• the CSOP exercise period extends to 15 years, and HMRC says existing CSOP option agreements can be amended to benefit;
• EMI option holders get 180 days, rather than the current 90, to exercise after a disqualifying event, according to HMRC’s impact note. The government’s response to its call for evidence, published the same day, says 120 days, so the Bill will settle it.  HMRC says the longer period also applies to existing options where the disqualifying event occurs on or after 6 April 2027, although the option agreement itself may also need to allow exercise that late; and
• EMI’s exception for employee ownership trusts extends to companies arranging to come under an employee ownership trust’s control.

As previously announced, and covered in our July Insight, companies will no longer have to notify HMRC of each EMI grant: options granted from 6 April 2027 are reported through the end-of-year return instead (OOTLAR, paragraph 1.7).  For scale-ups that have outgrown EMI’s company limits but meet the CSOP conditions, a £120,000 EMI2 allowance per employee is useful.  Welcome, but small beer.

Plenty on AI, little on the payroll

There was plenty on AI.  The speech promised an extra £500m for AI safety and security and another £140m for the Sovereign AI Unit.  Four days earlier, the Treasury had announced an additional £23m over three years for the AI Economics Institute, a government-backed body “dedicated to analysing the economic impacts of AI”.  The government is also investing in AI across the civil service to support a further £600m of back-office savings.

What the Budget did not offer was a clearer answer on what AI, and the swarms of agents coming next, could mean for hiring, for payrolls and for the income tax and NICs base that pays for everything else.  Employer NICs remain at 15% on most employees’ earnings above £5,000 a year, and most NIC thresholds stay frozen until 2030-31.  When salary above £5,000 a year carries employer NICs at 15% and software carries none, the incentive is to grow without adding headcount.  The employers we talk to are holding headcount or cutting it.

Nothing in the Budget joins that up with the new relief.  Founders’ Relief offers a headcount test that rewards a company for growing its full-time workforce at an average of 25% a year, exactly the hiring the rest of the tax system currently discourages, although a company can qualify through turnover growth and R&D instead.  For the people a company does hire, tax-advantaged options remain one of the most tax-efficient ways to share the upside.  An EMI option with an exercise price at least equal to the shares’ market value at grant, or an EMI2 option exercised within its tax-favoured window (currently three to ten years after grant), generally carries no income tax or NICs on exercise.

What to do now

• Founders incorporating now: consider the proposed 25% test before trading or preparations for trading begin, and preserve evidence of the relevant date and shareholdings.
• Founders who might qualify: check the company’s R&D claims, the continuity of its trade and its growth record against the tests, preserve evidence of who held what when trading, or preparation for it, began and of each growth test until any HMRC enquiry into the claim has closed, and build information and co-operation rights into any sale documents.
• Anyone selling in the next year: look hard at timing against 6 April 2027, and at the transitional rules once they are published.
• Companies relying on non-competes: the government will legislate so that non-compete clauses are no longer a barrier to hiring, with a detailed position promised in early 2027. Review how service agreements and incentive terms protect the business, because leaver provisions and vesting may need to carry more of the retention weight.
• Anyone with a view on the design: the consultation closes on 30 November 2026, with responses to EnterpriseTax@hmtreasury.gov.uk.

All the thoughts and commentary that HLaw publishes on this website, including those set out above, are subject to the terms and conditions of use of this website.  None of the above constitutes legal advice and is not to be relied upon.  Much of the above will no doubt fall out of date and conflict with future law and practice one day.  None of the above should be relied upon.  Always seek your own independent professional advice.

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