Incentivising your employees with growth shares

What are growth shares?

Growth shares can be a great solution for incentivising ambitious employees and directors of fast growth companies. Growth shares are a special share class created by a company. They allow the holder to participate in a proportion of the value of the company above a specific valuation hurdle. This means that the holder of these shares does not benefit from any value of the company below the hurdle. The hurdle attaching to growth shares can be set at the current market value of the company, or at a premium.

The diagram below illustrates how this works:

The hurdle is represented by the pink horizontal line. All value below the hurdle is delivered to the non-growth shares. Above the hurdle, the value is delivered partly to the growth shares (dark blue) and partly to the non-growth shares (light blue).

When growth shares can be helpful

They are commonly used where:

• The company has significant existing value that it wants to protect
• The company is anticipating high growth, e.g. private equity-backed companies
• The company does not qualify for tax advantaged share plans. These include the enterprise management incentives (EMI) share option plan and the company share option plan (CSOP)
• The individual does not qualify for EMI or CSOP
• The EMI and CSOP individual value limits (£250,000 and £60,000, respectively) are insufficient

Advantages and disadvantages of growth shares

The key benefits are:

• They ringfence value: Growth shares ringfence the value below the hurdle for the original shareholders. The growth shareholders will only be entitled to a percentage of the value above the hurdle
• They are likely to be more affordable for employees than fully participating shares: As the shares do not participate in the full value of the company, their market value tends to be lower than fully participating shares. This can help reduce the cost of the shares to employees or reduce the tax charge if the shares are issued for less than market value
• They provide strong motivation for employees: The nature of the arrangement can make growth shares an excellent tool for motivating employees to grow a company. If the company doesn’t grow, the value of their shares will not grow. They therefore align the interests of the current owners and employees
• They’re tax efficient: If structured carefully, gains on growth shares should be subject to capital gains tax (CGT). As the main rate of CGT on shares is 24%, this can be very attractive compared to bonuses and “unapproved” share options. These both attract income tax at up to 45%, employee’s NIC at 2% and employer’s NIC at 15%
• Anyone can participate: There are no participant requirements – anyone can be awarded growth shares. This includes consultants, part time staff and non-executive directors. Nor are they subject to any limits on the total value of the shares awarded
• Flexibility: Growth shares are very flexible and can be subject to specific performance and leaver conditions. They can also be issued on ‘nil paid’ or ‘partly paid’ terms.

The downsides are:

• Limited upside in slower growth businesses: Growth shares work best in fast growth businesses. If your business does not have strong growth prospects, the concept of a share which only participates in growth may not provide suitable motivation to your employees
• The valuation of growth shares can be complicated: As they are, by definition, “underwater” from the outset, common valuation methodologies to determine present value (such as those based on net assets or historical earnings) are not seen as appropriate. HMRC’s published stance is that growth shares must always be worth something. Therefore, the valuation must take a forward-looking approach which reflects the “hope value” of the shares. The methodologies used to establish the value of growth shares tend to be complex and it is common for a valuer to employ more than one of them
• There are tax risks: The company’s articles of association and other legal documentation must be carefully drafted. Poorly structured “return of capital” rights can trigger unexpected income tax charges under the employment related securities (ERS) legislation. In certain circumstances, growth share arrangements can inadvertently fall within the convertible securities tax charging provisions.
• Other routes may be more suitable: If tax advantaged share option plans are available, these should be considered first. Unlike a direct issue of shares (including growth shares), an option involves no upfront cost to the employee. Another useful feature of tax advantaged share schemes is that the valuation can be agreed with HMRC in advance, which reduces the risk. It is possible to grant EMI and CSOP options over growth shares, but this is a topic which requires its own blog

How we can help

If you feel that a growth share plan could be the right fit for your business, we would love to speak with you to explore how we can help.

Our specialist share plan and valuation teams can guide you through the process of implementing a growth share plan. We will ensure that it serves as a powerful tool to motivate and retain your key people.

We can:

• Work with you to design a plan which delivers your commercial objectives
• Value the growth shares for tax purposes
• Provide tax advice on the arrangement
• Review the legal documentation drafted by your lawyers
• Assist with your communications with your employees to ensure maximum incentivisation
• Help you register the growth share plan with HMRC and file an ERS return to report the share issue