Out-Law Guide 5 min. read
25 May 2022, 12:54 pm
Growth shares are typically granted by private, unlisted, companies in the UK, though they are sometimes issued by subsidiaries of AIM-listed companies too. Growth shares can be used as an alternative to, or in conjunction with, EMI options. They can be a particularly attractive tool for recruiting and retaining staff for companies operating in high-growth sectors such as technology and life sciences where they otherwise lack the financial clout of larger, more established businesses that pay larger salaries.
Growth shares are a different class to the ordinary share capital and will typically confer no rights to dividends or voting. The shares will often be restricted to participation on an exit only basis, for example, on the sale of the company or an initial public offering.
Growth shares are subject to a 'hurdle' to encourage future growth of the company. If a company is currently worth £10 million, the growth shares could, for example, set a hurdle that states holders of growth shares will only share in any exit proceeds above £12 million.
Since there is a possibility that the company will not achieve the growth required to benefit from the shares, growth shares can have a relatively low market value when issued to employees compared to ordinary shares. This makes it more affordable for employees to invest in the company.
As growth shares only allow their holders to share in the future growth of the company, there is no dilution for existing shareholders in respect of the current "built-in value" of the company at the date the growth shares are issued.
Growth shares can be used in conjunction with an Enterprise Management Incentive (EMI) plan and this can be particularly useful where the higher value of the ordinary shares means the company would struggle to make meaningful grants within the £250,000 individual limit. However, unlike EMI options which must be exercised within 10 years of being granted, growth shares do not have a time limit and may therefore be a suitable alternative for companies that do not expect to exit in the near to medium future.
Vesting and leaver provisions can apply to the growth shares so in effect the arrangements commercially mirror a market value option arrangement.
The tax treatment of a subscription for growth shares is best illustrated by way of example: say a company is worth £10 million at the time of issue of the growth shares and an employee subscribes for shares that gives the employee 1% of the company value above a hurdle of £12 million. In this example, the growth shares have been valued at £1,000 at the date of subscription and the employee pays the full market value for the shares which means that there is no tax or National Insurance contributions (NICs) to pay on issue. If the company is subsequently sold for £20 million, the value of the growth shares will be £80,000 – this being 1% of £20 million less £12 million. The employee's gain of £79,000 – the £80,000 exit value less the £1,000 paid for the shares at the outset – will be subject to capital gains tax (CGT).
If, rather than pay for the £1,000 market value of the shares in the above example, the employee is issued the shares at a discount, in addition to the CGT on disposal of the growth shares, the discounted element would be subject to income tax and possibly NICs too at the date of issue of the growth shares.
The market value of a growth share cannot be agreed with HM Revenue & Customs (HMRC) so it is vital that the company conducts a robust valuation and maintains accurate records to justify the valuation in the event it is challenged by HMRC in the future.
Growth share plans can therefore be a form of tax efficient incentive for employees with low acquisition costs and CGT treatment on growth. However, this will only remain the case if:
Employees should therefore be told of the risk that the tax treatment of the growth shares may change after acquisition.
The advantages include the following:
The disadvantages include the following:
The following steps are usually taken to set up a growth share plan:
Growth shares arrangements can be relatively straightforward and are an attractive alternative to non-tax-advantaged share options or where ordinary shares in the company would have a high market value, and the employee would be unwilling or unable to pay the full market value on acquisition. Companies that find themselves unable to grant qualifying EMI options or are struggling to stay within the individual EMI limits should consider using growth shares to incentivise employees.
25 May 2022
26 May 2023