Growth shares entitle key employees to share in the future growth of the company. They are commonly used to reward or incentivise employees but can also be useful for effective inheritance and succession planning.
What are growth shares?
They are a separate class of shares that allow participating employees to share in the future growth in value of the company. There are variations, such as flowering shares and hurdle shares but the basic concept is very similar.
The rights given to this class of share mean that the shareholder only benefits from the growth in value of the company above a set hurdle. The employee has a big incentive to help grow the company because they get a share of the increase in the value of the company.
They are usually subject to restrictions on transfer, or forfeiture if specified conditions or targets are not achieved or if the employee ceases employment.
The benefits of growth shares
They can offer a number of benefits including:
- They incentivise employees to grow the business.
- Help to preserve the existing value of the company for current shareholders and prevent this value from being diluted.
- The growth in the share value is subject to Capital Gains Tax, which is typically more attractive than the income tax treatment that would apply to salary, bonuses, or non-tax advantaged share options. This is particularly attractive to employees in high growth companies.
- Can typically be issued or transferred to employees for a low purchase price or low initial tax charge. This is because the initial value of the shares is usually much lower than existing ordinary shares as the shareholder only benefits from the growth in value above the set threshold.
- Can be used for effective inheritance and succession planning. They can enable all or part of the future growth in the value of the company to be transferred to family members, whilst retaining the current value.
A company is valued at £1m and it is envisaged that with the help of a key employee the company could be worth £4m or £5m in 5 years’ time.
Growth shares are created which are entitled to 10% of the company value above the equity hurdle of £1.2m. The key employee is given 10% of the growth shares.
For illustrative purposes say the employee’s growth shares are valued at £2,000. In reality, a valuation exercise would need to be undertaken to support the initial value. The employee can either buy the growth-share at this price or receive the shares for no consideration and pay income tax on the initial value of £2,000.
If the company is sold for £5m, the key employee’s growth shares would be worth £380,000 (10% of the value above the £1.2m hurdle), which would be a great bonus for them. The founding shareholder would be entitled to the remainder.
Growth shares may not be the best option if your company has no real value yet or the growth shares are being gifted to your partner.
There are many other ways of using shares as an employee incentive including the EMI share options scheme.
How we can help
We would be happy to advise you further in relation to the use of growth shares or employee share schemes. Please contact us for further information.
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