We have recently seen a surge in businesses issuing growth shares. So what is behind the rise in growth share schemes and what benefits do they offer?
Growth shares are shares that will only share in the benefit from an increase in the value of a company over a certain amount – they only share in the ‘growth’ of the company beyond that point in time.
For example, if there were a company that with a valuation of £10,000,000 and growth shares were issued constituting 10% of the share capital (the rest of the shares being held by the founders), if all of the shares in the company were sold for £15,000,000 a few years later, the growth shares would be entitled to 10% of the £5,000,000 growth above £10,000,000, which would equate to £500,000. The founders would be entitled to the remaining £14,500,000.
Other related types of shares include “flowering shares” (which only gain rights once a certain trigger event has occurred, e.g. no voting, capital or dividend rights until the company’s turnover reached a certain figure) and “freezer shares” (which only have a capped value and do not participate in future growth of the company).
Typically, growth shares are issued to key employees to incentivise them. They will usually be issued on terms that if the holder leaves employment they will have to sell them back to the company (or other shareholders) and if they do not leave in good circumstances then the price for the transfer back will be minimal.
One key advantage in growth shares is that the existing shareholders can incentivise key employees without giving away any of the value that they have already built up in the company. If they were to to issue ordinary shares (which rank the same as the existing shareholders’ shares) then the value of the existing shareholders’ shares would be diluted and the existing shareholders will have given away the value they have built up. Growth shares allow the existing value to be protected while at the same time incentivising employees to drive growth in the company.
Growth shares are also often used as a tax-efficient way to incentivise employees when tax-advantaged share options (such as enterprise management incentive options (EMI Options)) are not available to the company, for example because the company has already exceeded the limit for granting EMI Options (i.e. £3million by reference to the value at the date of grant of each EMI Option) or does not carry on a qualifying trade.
From the perspective of an employee obtaining growth shares, they will get to share in the future growth of the company, which may prove to be valuable, and there are also likely to be tax advantages. If they were simply issued with ordinary shares then they would either have to pay full value for the shares (which is not good for incentivisation and may not be affordable) or could be hit with a substantial tax bill (as HMRC will treat any value gifted to an employee as income for tax purposes). Because growth shares only have a minimal value at the time they are issued (because most or all of the capital value will have been retained by the existing shareholders) the tax implications and issue price for the shares should only be minimal, making them relatively low risk for employees.
Growth shares will not ordinarily entitle the holder to entrepreneurs’ relief, however, if they are issued under an EMI Option then the growth shares can also have the benefit of entrepreneurs’ relief when they are eventually sold. EMI Options can (at the time of writing) also bring benefits to the issuing company, in the form of corporation tax relief. Combining EMI Options with growth shares can (at the time of writing) be particularly tax-efficient because more options can be granted within the EMI individual limit (i.e. £250,000 for each individual), as the market value of a growth share is less than the value of an ordinary share.
Growth shares are a good way to incentivise key employees by allowing them to share in the capital growth of the company, without giving away the value that has already been built up. Growth shares can also have tax advantages when compared (or combined) with other methods of incentivising employees.