Are growth shares better than options?

Growth shares and share options are two types of incentive arrangements which businesses implement to recruit, reward and incentivise their workforce. Growth shares offer an effective solution when restrictions prevent the implementation of an EMI share option scheme.

Despite their limitations, growth shares can still offer substantial tax benefits to employees. It’s important to understand how each arrangement generally works to choose the right plan for your business.

In this edition of Ask the Expert, we set out some key advantages and disadvantages of both to help you decide which arrangement would work best for your business.

What are growth shares?

Growth shares are a special class of shares designed to be issued to management and other senior workforce. At a sale or other liquidity event, growth shareholders will receive share proceeds above a company equity value which is set at the outset. The incentive works by rewarding management to grow the company above a specified value so that management receive a financial reward when other shareholders receive a financial reward providing alignment of interests.

What are options?

Options are rights to acquire shares at a future point in time which is commonly a sale or other liquidity event. Unlike growth shares, managers do not hold actual shares on day 1, and only receive shares following a financial or other trigger.

Some options qualify for tax benefits which make them very tax-advantageous for the manager and the company. The most tax-advantageous option scheme is the Enterprise Management Incentive (EMI Scheme) which is subject to various legislative conditions and financial limits.

Are growth shares better than EMI options?

No. Where your company and employees circumstances meet the EMI legislative criteria, EMI options will generally be preferrable to awarding outright growth shares. That’s because for a UK taxpayer and UK company, the EMI scheme includes the following benefits:

• The valuation can be approved by HMRC which gives certainty to the parties as to valuation.
• There is no manager funding requirement to buy shares or pay tax at the time the shares are awarded.
• Managers can access a 10% rate of capital gains tax (CGT) on the sale proceeds of the shares less the exercise price where the exercise price is not less than the market value at grant.
• The employer company may obtain a statutory corporation tax deduction at the time of exercise of the option on the difference between the market value of the shares and the exercise price, even though the manager is taxed at CGT rates.

Are growth shares better than non-tax advantaged options?

It depends on a few different scenarios:

From a manager perspective

Growth shares are better for a manager from a tax perspective. When a manager sells a growth share, the difference between the sale proceeds and the market value at award should generally be taxed as a capital gain at lower tax rates than salary and without national insurance contributions (NIC). Non-tax advantaged options don’t provide any tax breaks for an employee. That means the benefit at the time of exercise is taxed as salary and subject to income tax at the employee’s marginal rate. NIC can also apply to the benefit for the employee and the company. The tax treatment of options is different for consultants.

Managers can also receive dividends on growth shares unlike share options.

From a company perspective

From the company’s perspective, growth shares will require changes to the articles of association and possibly any shareholders’ agreement. Growth shares can also be more complex to explain to managers, so resources and potential training may need to be provided.

Growth shares can be more complex to operate particularly in relation to leavers which makes them less suitable for incentive programmes with large numbers of participants.

From a shareholder perspective

For the current shareholders in the company, growth shares can be better as they don’t generally dilute the current equity value at the time of award.

Are there any disadvantages to growth shares?

A potential disadvantage of a growth share is there is a funding requirement to buy the shares on day 1 or otherwise the value of the share is taxed at income tax rates and sometimes NIC applies to the benefit too. This exposure can be reduced depending on how the scheme is designed but the growth shares will have some value for tax purposes, even if they aren’t in the money on day 1 (in other words if the business was sold on day 1, the growth shares would not receive any value).

I want to set up a share option plan. What next?

Our expert employee share scheme team can help you design, structure and implement a growth share or other share option arrangement so that you and your team achieve the maximum benefits available.

Contact us by filling out the short enquiry form below and a member of our team will be in contact.

In the mean time, you can find out more about growth shares in our frequently asked questions.