As your business grows, implementing growth shares can be a powerful way to attract, retain, and incentivise talent. Growth shares offer a valuable alternative when tax-advantaged options like EMI or CSOP aren’t available, allowing employees to directly benefit from the company’s success.
In this article, we’ll walk you through how growth shares work and provide practical insights on how to navigate the process, drawing from our experience helping businesses design and implement successful growth share schemes.
Contents:
What are growth share schemes and how do they work?
Growth shares reward senior employees with shares at a low acquisition value, reducing upfront costs and income tax and national insurance contributions. Employees only benefit from growth beyond a set hurdle, preserving the company’s value for founders. This is useful when founders plan to exit and other tax-efficient options aren’t available.
Unlike share options, which trigger income tax on the difference between market value and purchase price, growth shares offer less tax exposures for the company and the holder and only gain value if the company exceeds the hurdle. For example, if your company is valued at £5M and you issue 10% in growth shares with a 10% hurdle, employees only benefit if the value exceeds £5.5M, aligning their incentives with company growth.
What are the different types of growth share scheme?
Growth
Growth shares are shares that are designed to only provide a financial benefit to the holder of those shares if the market value of the company increases after the date the shares are issued. So, if the ordinary shares are worth £10 per share when the growth shares are issued, then the holder will only receive a benefit if ordinary shares are worth more than £10 on exit.
Hurdle
Hurdle shares are like growth shares but are designed to benefit the holder if the market value of the company increases beyond a set amount over and above its market value at the time the hurdle shares are issued. So, if the market value of the company’s shares is £10 each at issue, and the hurdle is set at £12 per share, the holder will only benefit if ordinary shares are worth £12 or more on exit.
Flowering
Flowering shares are a type of growth shares that only benefit the holder if certain performance conditions are met, for example if the company achieves a certain level of profits. Sometimes these arrangements enable participants to share in value below the performance condition, if the condition is met. In this case, the share will be more expensive on acquisition.
Practical considerations of growth shares
Advantages
- Minimal dilution – Since growth shares have little value at issue, existing shareholders aren’t financially diluted until the company’s value surpasses the hurdle.
- Tax-efficient – Employees can buy shares cheaply with little income tax or national insurance contributions. Future gains are taxed as capital gains, which often have lower rates.
- Flexible rights – Growth shares can have restricted voting, dividends, and transfer rights. The company can also reclaim them if an employee leaves.
- Dividend payments – Unlike share options, growth shares allow the company to pay dividends to employees.
Disadvantages
- Tax treatment risks – Their benefits depend on tax rules staying the same, including the relative rates of income and capital gains tax.
- Limited suitability – Best for private limited companies that are already successful and have strong growth potential.
Administrative burdens and costs
- Legal changes – The company must amend its Articles of Association, issue new shares, and file documents with Companies House.
- Valuation requirements – A share valuation expert is needed to assess the market value of the company and its growth shares.
- Growth-dependent – Growth shares are most effective when the company is expected to grow within a reasonable timeframe.
- SEIS/EIS considerations – Careful planning is needed to ensure growth shares don’t interfere with SEIS or EIS tax benefits.
What are the main characteristics of growth share schemes?
Right to capital
Holders of growth shares won’t receive any proceeds upon the sale of the company unless the hurdle amount is reached.
It’s important to get lawyer advice when structuring the hurdle conditions clearly and ensuring they align with the company's long-term objectives, protecting both the shareholders and the business.
Dividends and liquidity events
Growth shareholders may receive dividends, but this is typically a commercial decision with valuation and cost implications. Dividends increase share value, which may raise the hurdle to keep the acquisition price low. They also depend on the company's distributable profits.
It's usually more tax-efficient for managers to extract value through a sale of growth shares during a liquidity event, as capital gains tax (20%) is lower than the dividend tax rate (up to 39.35%).
A lawyer can advise on the relevant considerations relating to giving dividend rights to growth shares.[TB1]
Right to vote
Growth shareholders typically don’t have a say in the company’s affairs.
Getting legal advice can help draft clear documentation that outline voting rights, ensuring the company’s governance structure meets the needs of both founders and investors.
Leaver provisions
Employees with growth shares usually need to return them to the company if they leave. The conditions under which this happens should be set when the growth shares are issued, and these provisions can vary depending on whether the employee departs on good or bad terms.
Lawyers can help draft appropriate leaver provisions that protect the company’s interests while ensuring fairness and clarity for departing employees.
Valuing growth shares and setting the hurdle
Growth shares should be valued much lower than ordinary shares, but still have some value at acquisition, as expected by HMRC. A formal valuation is required when issuing the shares. The hurdle is a financial target that must be met for employees to benefit from the growth shares.
EIS and SEIS compatibility
Issuing growth shares alongside SEIS or EIS funding could risk losing the tax reliefs. These schemes don’t allow preferential dividend or liquidation rights, so growth shares must be structured carefully to comply.
How do I create a growth share scheme?
There are no qualifying criteria to create a growth share scheme.
Setting up a growth share plan requires a proper company valuation by an expert to avoid issues during due diligence. You'll need shareholder approval to amend the Articles and issue new shares, which should outline the rights of the growth shares, including leaver provisions. A subscription agreement must then be signed with employees to issue the shares.
Partnering with experienced lawyers ensures your growth share arrangement is structured properly, reducing risks and enhancing benefits for both your business and employees. A carefully designed scheme can offer substantial tax advantages and long-term value, making it an effective tool for attracting and retaining top talent.
If you’re ready to implement a growth share scheme, call us on 0800 689 1700 or submit your query via the contact form below, and one of our team members will get in touch.
