What are Growth Shares?
Growth shares are a special class of shares that allow the holder to only participate in capital value generated through growth of the company above a specified threshold. For example, if at the point the shares are issued the company is worth £500,000, the holder of growth shares might only participate, and on a sale of the company receive a share, in any growth above £500,000.
How are Growth Shares used?
Growth shares are frequently used to incentivise key employees to contribute meaningfully to a company’s success without giving away a stake in what the original owners of the company have built. Instead, they only benefit from future growth.
The use of growth shares is often (but not always) tax driven. This is because employees and directors (executive or non-executive) who subscribe for or acquire shares in the company/group for which they work, are within the scope of special tax rules applying to employment related securities. In summary unless full market value is paid for shares there is an income tax charge (and potential national insurance charges) on the discount. Therefore, if ordinary shares in the company are issued or transferred to employees, they need to pay full value to prevent the discount of the shares being subject to income tax charge (and potential national insurance charges). If therefore the value of the shares is such that the employee cannot afford to either pay their full market value or the tax on the discount, growth shares might be a solution, as they will have a lower market value at the point of purchase.
In summary, why should you consider growth shares
- Aligned incentives: employees profit only from future growth, not existing value.
- No dilution of current value: existing shareholders’ equity in relation to current value remains unaffected.
- Lower cost of entry: growth shares are typically more affordable than ordinary shares.
- Tax benefits: growth in value should be subject to capital gains tax rather than income tax.
But it’s not without risks, so always be mindful:
- They must be carefully structured to protect existing shareholders (particular care is required if there are any SEIS or EIS investors to ensure the growth shares do not invalidate the qualifying status of the SEIS or EIS shares).
- Valuation is key and tax implications can be complex and need expert guidance.
- Employees are making a real financial investment in the business. So, they need to be aware of risks and rewards.
- Mechanism required to be able to take the shares back if the employee leaves.
