Growth shares are a class of equity shares given as an incentive to employees. Growth share schemes are complex, which is why we've created this initial guide to answer your most common questions. Our corporate solicitors are also on hand to advise your business on designing and implementing a growth share scheme.
- What are growth share schemes?
- How can growth shares be used?
- What are the advantages and disadvantages of growth share schemes?
- The differences between growth shares and Approved and Non-approved share schemes
- What are the qualifying criteria to create a growth share scheme?
- Can growth shares be implemented alongside EIS & SEIS?
- Characteristics of growth shares
- How are growth shares valued?
- Steps to set up a growth share plan
What are growth share schemes?
Growth shares schemes are a device used (generally) by private limited companies to incentivise senior employees. They are a more efficient way to offer company shares to staff members (or advisors/non-executive directors), as the recipient will neither face an income tax charge on the issuing of the shares, nor required to make a large capital investment up-front.
In normal circumstances, when a company issues shares, the purchaser is required to pay the market value of those shares. If the company offers its shares to employees at a discount from the market price, then this will trigger an income tax charge on the difference between the price paid for the shares and the market price at the time of issue.
Instead, and to avoid such charge, the company could create a special class of shares, known as ‘growth shares’, and issue these shares to the employees.
Growth shares are a special class of shares in which shareholders can only benefit from the company’s increase in value from the date the shares are issued. So, if the company is worth £5,000,000 when it issues the growth shares to an employee, the employee will only benefit if the company grows above £5,000,000 in value.
The market value of growth shares is much lower than ordinary shares as they have few rights attached to them, making them much more affordable for employees.
How can growth shares be used?
Companies use growth shares to reward and incentivise key members of staff. Staff are able to purchase shares in the company without having to pay the full market value of ordinary shares.
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 shares are similar to 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 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.
What are the advantages and disadvantages of growth share schemes?
- As growth shares have little real value when they are issued, and are a special class of share, the holdings of existing shareholders are not diluted by the issue of growth shares
- They are a tax efficient way of rewarding employees, because of their low market value. They are not deemed to represent disguised income to the employee and thus attract a charge to income tax or National Insurance
- The purchasers of growth shares don’t have to find a large capital amount to pay for them as they are much cheaper to buy than the company’s ordinary shares
- Growth shares can be designed so they are restricted in terms of voting, dividend and other rights that attach to ordinary shares. The company can also require that they be given up if the employee leaves
- Capital gains tax will be payable on any increase in value of the shares, but these rates are generally lower than higher-paid employees’ marginal income tax rates
- The tax advantages of growth shares depend on their being no changes in tax treatment or in the relative rates of income and capital gains tax
- Growth share schemes are usually only suitable for private limited companies that can have more than one class of share, who are already successful and have a reasonable prospect for future growth
- There are some administrative burdens and costs
relating to growth share schemes for the company:
- The company’s articles will need to be amended, new shares issued, and filings made at Companies House
- The company will need to ascertain its market value and the value of the growth shares by engaging an expert
- The company will need professional advisors to draft the growth share plan and make the necessary changes to the company’s constitutional documents
- Growth share are only a realistic option if the company can expect to grow within a reasonable period of time and thus offer a substantial benefit to employees
- Growth shares can’t normally be issued if the company has received investment via the Seed Enterprise Investment Scheme (SEIS). Or Enterprise Investment Scheme (EIS) as the growth shares can’t be issued with fewer rights than the SEIS or EIS shares
The differences between growth shares and Approved and Non-approved share schemes
With a growth share scheme, a company can issue shares to employees immediately, without any income tax being payable by the employee when they receive the shares.
In addition, there are certain share option schemes whereby a company can incentivise employees by granting them options to purchase shares in the future, without income tax being payable either when the option is granted or when it’s exercised, and the shares issued.
With Approved share option schemes (CSOPs), participants are granted the option to purchase shares in the future at a fixed price. No income tax is payable on the grant of the option or when the option is exercised, and the company will receive a corporation tax deduction for the difference between the market value of the shares and the price paid by the employee. Capital gains tax is payable on any gains made on sale of the shares.
With Non-approved share option schemes, income tax is payable at the time of exercise of the share option.
Both growth share schemes and Approved share option schemes allow companies to issue shares to employees without attracting an income tax charge at the time that shares are issued. In contrast to growth share schemes however, Approved share option schemes require HMRC clearance and the terms of such schemes are restricted.
What are the qualifying criteria to create a growth share scheme?
There are no qualifying criteria to create a growth share scheme.
Can growth shares be implemented alongside EIS & SEIS?
If the company has raised funding under an investment scheme such as the SEIS or the EIS and wants to issue growth shares, it may risk losing the tax reliefs available under those schemes. This is because SEIS and EIS shares cannot be issued at a preference in terms of dividends or on a winding up, and growth shares may be deemed to be subordinate to SEIS or EIS shares in this respect.
Characteristics of growth shares
Where growth shares have been issued, the holders of those shares won’t receive a share in the proceeds of sale of a company unless a certain fixed amount has been distributed to the other shareholders (representing the market value of the company when the growth shares were issued).
Growth shares usually come with no, or restricted, rights to receive a dividend.
Usually growth shares don’t come with voting rights.
Normally employees who have been issued growth shares will have to offer them back to the company if they leave. The terms of that sale may depend on the circumstances of the departure, and this will have been drafted into the subscription agreement at the time the growth shares were issued.
How are growth shares valued?
As we’ve seen, the initial value of growth shares is negligible.
However, in order to provide comfort that the issue of growth shares will not attract an income tax charge, you will need to have an independent valuation of your company as well as the growth shares to demonstrate this. The valuer will conduct an appraisal of the company and may apply a premium on the market value to reflect the ‘hope’ value of the shares.
Steps to set up a growth share plan
Here are the steps to set up a growth share plan:
- Amend the company’s articles to create the growth shares and describe their rights in relation to other share classes, as well as any leaver provisions
- Set up the growth share plan and enter into a growth share subscription agreement with the relevant employees
- Obtain shareholder agreement to the amendment of the Articles and issuing of new shares
- Obtain a valuation of the company and the growth shares
- Issue the growth shares