Growth shares are, in essence, a separate class of incentive shares which entitle participating employees to share in a proportion of the future growth in value of a company.
In many cases, a further hurdle is also set (often slightly in excess of current value) at which point the employees’ growth shares become entitled to share in value. In that way, growth shares commercially work like a market value or above market value share option.
Employees may benefit from dividends but more typically they only receive economic benefits from their growth shares on an exit or other realisation event to the extent that the hurdle is exceeded.
- Growth shares reward employees for delivering growth in company value by enabling employees to share in a proportion of that future growth.
- Growth shares help to protect existing shareholders from dilution by ring-fencing current value for them and are therefore an effective anti-dilution tool.
- Growth shares are low-risk mechanisms which offer potentially significant tax savings for both the company and employees.
- Growth shares are flexible and can be designed to meet the specific objectives for the company in question.
Other types of scheme
From an existing shareholder perspective, growth shares help to manage any dilution of existing value and motivate key employees to generate future growth for the benefit of growth shareholders and existing shareholders alike. They therefore play a key role in aligning shareholder and key employee interests.
Growth shares also offer potentially significant tax savings to both employees and the employer. Due to the lack of economic entitlements when the growth shares are actually acquired, their full unrestricted market value should be relatively low, reflecting the fact that when they are acquired they have “hope value” only.
The cost (or tax cost) to employees of acquiring their growth shares is therefore made more affordable and the downside risk to employees is also reduced.
Growth shares are commercially flexible and can therefore be made forfeitable on employees leaving, with relevant restrictions or rights applying in relation to votes, dividends and other shareholding rights. Performance or time based vesting triggers can also be added.
If employees pay full market value for their growth shares there should be no income tax or National Insurance contributions liabilities on either the acquisition of the shares or on their growth in value. Growth shares acquired at a discount can still give rise to such liabilities but on a significantly reduced value when compared to “full value” shares.
The more beneficial rates of capital gains tax (between 0%-20%) should then apply to any future growth in value of the shares. This compares very favourably with unapproved share options, cash bonuses and phantom share options.
Growth shares can be used effectively as part of an Enterprise Management Incentive (“EMI”) option to combine the commercial benefits of growth shares with the enhanced tax breaks offered by EMI.
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Growth shares require a new class of share and may not be feasible in all cases. Care must be taken if the company has or is looking for investment via the Seed Enterprise Investment Scheme (“SEIS”) or Enterprise Investment Scheme (“EIS”) as growth shares cannot have lesser dividend and/or winding up rights than the SEIS or EIS Shares.
Unless EMI is used, the value of the growth shares cannot be agreed in advance with HM Revenue & Customs. However, independent professional valuations will usually provide a good degree of comfort, both in terms of valuation and the likely tax implications of acquiring growth shares.