Growth shares are a particular type of ordinary share that companies can use to attract, incentivise, and retain key talent. Sometimes referred to as hurdle shares or value shares, they allow employees and other individuals to benefit from the growth of a company’s value above a certain amount, rather than the existing ‘built-in’ value of the business at the time they receive their shares.
This article will help you to understand the basics of growth shares, including how they work, the benefits they can offer to companies and their employees, and the steps required to issue this special class of shares.
Understanding growth shares
Popular with startups, early-stage companies, and scale-up firms, growth shares are commonly issued to motivate and reward employees by enabling them to participate in a company’s future increase in value.
Essentially, the recipients benefit only from the success that they help to create after joining the company and taking the shares – not the value that was created before that time.
Holders of growth shares enjoy returns on the company’s growth in value when it exceeds a specified threshold, known as the growth or valuation ’hurdle’. Typically set as a premium over and above the current market value of the company’s shares, the hurdle acts as an incentive whilst preserving the economic interests of the existing shareholders.
- You decide to issue growth shares to a new key employee or director
- The company’s shares are currently valued at £10 per share
- You apply a small premium of 10% to set the hurdle at £11
- The growth shares have little to no worth until the value of the company’s shares exceeds £11
- The individual is entitled to a portion of the capital growth above the valuation hurdle
This type of share can be issued with full voting rights and dividend rights. However, they are typically non-voting, and many companies also restrict shareholder participation in the value of the company to exit events – for example, when the individual sells their shares or leaves the company, or upon the sale of the business.
Growth shares are typically used by private companies with significant growth potential, particularly early-stage businesses backed by private equity or venture capital investment. However, they are suitable for all types and sizes of private firms, as well as subsidiaries of Alternative Market Investment (AIM) listed companies.
Benefits of growth shares
Growth shares offer a flexible solution to a wide range of commercial objectives, providing benefits to both companies and the recipients of the shares.
1. Improve employee remuneration packages
For young companies that cannot afford to pay competitive salaries or bonuses, these shares can be used to create more attractive remuneration packages for new employees and executives.
By offering equity incentives, startups and smaller firms can level the playing field and bring in top talent without placing undue financial pressure on the business.
2. Low acquisition cost
Provided that the valuation hurdle is set at an appropriate rate, growth shares generally have no real market value upon their issue. This means that participating employees can acquire the shares for very little up-front cost.
If and when the shares increase in value above the hurdle, the employee shareholders can enjoy the financial benefits of the company’s growth in a tax-efficient manner.
3. Motivate and retain top talent
Since growth shareholders benefit only when the company’s value passes the hurdle, employees are incentivised to work hard to help the company grow and become more profitable.
Issuing this type of share can be an effective way to align employees’ interests with those of the business, encourage better engagement and productivity, and create a loyal workforce that adds real value to the business.
4. Available to anyone
You can issue growth shares to employees of the company as well as non-employees. This includes:
- full-time and part-time workers
- permanent and temporary staff
- new recruits and long-serving employees
- directors, company secretaries, and executives
- consultants and advisors
- contractors and freelancers
- overseas workers
- family members of the company owners (e.g. for Inheritance Tax or succession planning purposes)
Essentially, you can use them to incentivise and reward any individual who contributes to the success of the business, regardless of their role in the company, their length of service, or where they reside.
5. Preserve existing shareholders’ interests
Ordinarily, issuing new shares in a company dilutes the value of every other share. However, by issuing growth shares, companies can preserve the current value of each existing shareholder’s stake in the business. Their economic interests are only diluted if and when the company’s value exceeds the predetermined hurdle.
6. Efficient tax treatment
Provided that the recipient pays full market value, they won’t be liable to Income Tax or National Insurance contributions (NIC) when they acquire their growth shares, nor will the company be subject to employer’s NIC.
When the employee sells their shares, any increase in share value from the time of issue will be subject to Capital Gains Tax. This is a more attractive tax treatment than the Income Tax and NIC payable on salary, bonuses, and other types of employee benefits.
7. Flexible rights
There is no standard format for this type of share, so they offer greater flexibility than tax-advantaged ‘all employee’ share schemes. Companies can design the rights and restrictions attached to these shares to suit their specific requirements and corporate objectives.
Some companies attach voting rights to growth shares, whilst others do not. They may also provide full dividend rights, or specify conditional participation in profits instead, such as hitting performance targets or remaining with the company for a minimum period.
Most growth shares, however, carry no rights other than entitlement to a proportion of the company’s value above the hurdle on an exit. Whichever way they are structured, companies must record the shares as a separate share class in their articles of association, setting out the particular rights and conditions attached to them.
8. Alternative to EMI share options
Growth shares are more flexible than Enterprise Management Incentive (EMI) share option schemes, which are only available to certain companies and employees.
Unlike EMI options, they can be made available to anyone and they can be issued immediately, rather than being restricted to a vesting schedule. Moreover, growth share options do not expire after 10 years.
All of these features make them ideal for new recruits and long-term employees in growing businesses, with or without an exit event in the near future.
EMI options are only available to PAYE employees (including company directors) who work at least 25 hours per week, or devote at least 75% of their total working time per week to the business. Many companies, therefore, issue growth shares as an alternative to, or in conjunction with, EMI options.
How to issue growth shares in your limited company
To issue growth shares in your private limited company, the following steps are required:
- Obtain permission from the company’s existing shareholders to amend the articles of association and issue the new share class. They will be required to pass a special resolution at a general meeting or in writing to approve the proposed changes.
- Update the articles accordingly to reflect the new shares and the specific rights and conditions attached to them. Notify Companies House within 15 days of altering your articles of association.
- Carry out a company valuation to determine the current market value of shares and a suitable hurdle rate. For the most reliable valuation, it is best to use a qualified business valuation specialist such as a chartered accountant.
- Establish the growth share plan, outlining all of the particulars, rules, and requirements related to the new share class. These include the hurdle rate, qualifying criteria, shareholder rights and obligations, transfer restrictions, leaver provisions, and the conditions for receiving future dividends or capital distributions.
- Create a signed growth share agreement between the company and recipients, setting out the rights and responsibilities of all parties per the terms of the share plan.
- Issue the shares, provide a share certificate to each new shareholder, and enter their details in the company’s register of members.
- Complete form SH01 return of allotment of shares and deliver it to Companies House within one month of issuing the new shares.
- Notify Companies House of the new shareholder information when you file the next annual confirmation statement.
Before taking any of these steps, you may wish to speak to an accountant for expert advice and guidance on growth shares. They will also be able to advise on other types of employee share schemes that may be suitable for your limited company.
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