Growth shares are a new class of shares carefully drafted in a manner whereby usually employees of the company, family members, or potentially advisors and contractors, together the participants, can participate in the future growth of a company after the company has exceeded a fixed valuation. The growth share scheme provides certain taxation benefits and it's a useful tool in incentivising participants. They are often used where a company or the person who is being incentivised does not qualify for an HMRC approved share option or share incentive plan.
This article explains what growth shares are, how they operate, and why they’re increasingly used by companies to incentivise employees, family members, and advisors. It also explores the tax benefits, practical considerations, and scenarios where growth share schemes can add real value.
Growth shares are a share scheme commonly put in place by companies that strive for growth by means of incentivising its employees.
Growth shares schemes are also often utilised in family run businesses in separating the current generation and future generation. The existing shareholders will retain the value they created and ensure that the future generation is issued shares at a lower acquisition cost and correspondingly proceeds to strive for future growth in the company. The growth shares can act as a motivating drive force for the future generation in keeping the business running.
The participants in growth share schemes are only able to reap the benefits as and when the company is sold or it has listed after it has exceeded the fixed valuation. This valuation is commonly referred to as the ‘hurdle’. It's common for those who built up the initial value in the company and have held shares from an early date, the existing shareholders, to want security in that their equity will be protected. The hurdle operates in a manner whereby these existing shareholders retain and ringfence their existing value in their equity without a concern of future dilution by the issue of the growth shares.
Additionally the existing shareholders are able to benefit in future growth above the hurdle alongside the participants.
The hurdle also acts as a mechanism to depress the market value of the growth shares as at the date of issue so the participants can acquire the growth shares at a low market value (usually par value) in order to avoid an income tax charge. In some circumstances, a liability to national insurance contributions (NICs), both employers and employees, would arise if the shares were issued at a discount to their market value.
The growth shares are usually subject to restricted rights attaching to the shares like voting rights, dividend rights and rights relating to the distribution of assets and profits on a winding up to further depress their market value.
In comparison to salary increases and/or bonuses, the growth in the value of growth shares will also be subject to capital gains tax (CGT) which is at a much more attractive rate than that of income tax and NICs payable via pay as you earn (PAYE).
If the growth shares have limited voting rights it is however unlikely the participants will benefit from business assets disposal relief to reduce the rate of capital gains tax they pay.
It's common for the growth shares to have no rights to dividends under a growth share scheme, or alternatively the rights attached to the growth shares can be drafted in a manner whereby the participants can benefit from a smaller proportion of the dividends either from issue, or when certain milestones or hurdles are met.
Likewise growth shares tend not to have voting rights attached to them. However, should a company wish for the participants to benefit from business asset disposal relief, in respect of CGT, it may be that voting rights are provided to the participants and again this can be aligned with certain milestones or hurdles.
The growth share scheme can also be utilised in retaining key participants within the company. Cessation of employment provisions can be incorporated and separated into ‘good leaver’ and ‘bad leaver’ provisions. Ultimately ‘good leavers’ would be permitted to keep their growth shares as their cessation of employment was by virtue of retirement, ill-health, injury, redundancy etc. Whereas ‘bad leavers’ would lose the benefits of the growth shares as their employment cessation was likely as a result of circumstances deemed negative, for example gross-misconduct.
Bespoke rights and provisions can be included depending on the workforce environment and anticipated future circumstances.
The market value of a growth share, at the time of acquisition and following a formal valuation, will likely be lower than that of an ordinary share in the company. Growth shares will technically be worth a nominal value/worthless until the hurdle is met. Likewise, the price to be paid per share will usually be low or nominal making them a much more affordable and attractive investment for the participant at the outset and it also reduces the participants risk in the event the company is not successful.
If full market value is paid by the participant on the acquisition of the growth shares there will not be an income tax charge or in some instances a liability to NIC, both employers and employees.
Alternatively, if less than the full market value is paid, income tax and in some instances NICs, both employers and employees, can be due on the difference between the market value and the acquisition price paid per share.
When the growth shares are sold CGT will arise on the profit made, calculated as the difference between the sale proceeds of the growth shares less the cost of buying them. The current CGT rates are 18% for basic rate UK tax payers and 24% for higher or additional rate UK tax payers.
Business asset disposal relief could be available, but this is largely dependent on:
| This article is intended to be for general information purposes only, may not cover every aspect of the topic with which it deals, and should not be relied on as legal advice or as an alternative to taking legal advice. For further information, please contact our corporate tax team. |
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