Frequently Asked Questions
Growth shares can work in two ways:
- Where Growth Shares are awarded under a standalone Growth Share Plan, participants will purchase this special class of share directly and become shareholders in the company. The Growth Shares will initially have a relatively low market value in comparison to other share classes because of the hurdle that is attached. It’s common for Growth Shares to be structured without voting rights or dividend rights, which can reduce that initial value further. Growth Shares will only typically deliver capital value to the participants on a future liquidity event above the hurdle value.
- Alternatively, if companies qualify, it is possible to grant tax-advantaged Enterprise Management Incentive (EMI) or Company Share Option Plan (CSOP) options over Growth Shares. This has several advantages. Firstly, employees do not have to buy shares at the outset or create any up-front tax liabilities, but can choose to exercise options in the future, typically at the time of an exit or other realisation event, which means there is a reduced financial risk for employees. Secondly, if employees leave before an exit event, it is easier to “lapse” an option than it is to buy existing shares back from leavers. Thirdly, it is possible to agree the value of the Growth Shares with HM Revenue & Customs before options are granted and – this is not possible for a standalone Growth Share Plan. Finally, EMI and CSOP options carry specific tax advantages for both participating employees and their employing companies.
In addition to the tax and commercial considerations that are specific to Growth Shares, employee share plans of all types can have a positive impact on employees who can see the potential of personal gain if the company succeeds. They tend to be motivated to work harder and smarter, contributing to growth in the company’s value and seeing a clear alignment between their personal objectives and the company’s mission.
By offering Growth Shares, you not only motivate, build loyalty and commitment among employees, but also attract and retain top talent.
Research shows that equity-based compensation also leads to better long-term performance. By giving employees a financial stake, they put in extra effort, collaborate effectively, and boost overall company performance. Plus, as the company grows, so do the employees’ financial interests, duly incentivising them to stay in the business long-term.
Growth Share Plans can be a boon for companies that don’t qualify for HMRC recognised tax advantaged share plans such as EMI and CSOP. For example, subsidiary companies can use Growth Shares to motivate employees without using the share capital of the parent company; in addition, businesses under the control of external investors, including private equity firms, can also benefit. In some cases, where companies might qualify for EMI or CSOP, they may find that the financial limits attached to those tax advantaged plans are insufficient to deliver meaningful equity value to key staff: in particular, larger companies that can’t use EMI options may be limited to CSOP option grants over shares with a value of £60,000 to any one individual. By using Growth Shares, it’s possible to deliver option awards with a low value at the outset (thus maximising valuation limits), but with the promise of significant return once hurdles are exceeded.
In comparison to non-tax advantaged share options, cash bonuses, and phantom share options, Growth Shares offer a much better and tax efficient solution for rewarding the workforce. Employees who pay the full market value for their Growth Shares (valued at the time of award) are not liable for Income Tax or National Insurance contributions (NICs). Future growth in share value is then usually subject to more favourable CGT rates – typically at a rate of 20%, and with the possibility of taking advantage of CGT annual exemptions. Using Growth Shares within the wrapper of an EMI plan can also provide a 10% CGT rate as it is possible to take advantage of Business Assets Disposal Relief if the options were granted at least 2 years before the shares are sold. Employing companies may also make employer’s NICs savings as well when compared to non-tax advantaged share options, cash bonuses and phantom share options.
Although there are no legal restrictions in place preventing companies from setting up their own Growth Share Plan, we would strongly advise against it due to the commercial, legal, tax, valuation and accounting implications associated with a Growth Share Plan. There are also important compliance and administrative activities that need to be completed correctly to make your Growth Share Plan legally and tax compliant.
Working with employee share scheme experts helps you ensure that your selected plan is not only a good fit for your business and employees, but that it is economically feasible and does not pose unnecessary financial risks. Both HMRC and any future investor in/acquirer of any company will have a keen interest in how its employee share plans have been implemented and operated. Having specialist legal and tax knowledge on your side is also valuable when it comes to drafting plan documents, preparing and agreeing share valuations, employee communication materials and Growth Share subscription agreements.