Growth share plan

Growth shares provide an opportunity for employees and directors to acquire genuine equity in their employing company in a way that enables them to share in the real growth in the value of the business that they help to generate. A growth share delivers value to the employee shareholder if the value of the company increases above a set ‘hurdle’. Returns to employees from growth shares are subject to capital gains tax (CGT).

How it works

The company creates a new class of share. The share rights given to this new class of share mean that the share benefits from the growth in value of the company above an equity hurdle, but does not benefit from the value of the company below that equity hurdle. The equity hurdle will generally be set at a chosen premium above the market value of the company on the date of award of the shares.

For valuation purposes, as the shares only receive economic returns if the threshold is met, the initial value of the growth share is usually much lower than existing ordinary shares. Therefore, the growth shares can be issued or transferred to employees for a low issue or purchase price (or a low initial tax charge if the growth shares are acquired for no consideration).

The growth shares can be subject to restrictions on transfer, or forfeiture if specified conditions or targets are not achieved or the employee ceases employment.

The growth in the share value is subject to CGT which is more attractive than income tax that would apply to a cash bonus arrangement or non-tax advantaged share options. This offers a significant benefit to employees in high growth companies.

Example

A company is valued at £5m, and a manager is to be incentivised by being given up to 10% of the company value above the equity hurdle.

A new class of share is created which only benefits from capital value in excess of a £6m hurdle. These growth shares are entitled to 10% of the company value above the equity hurdle in excess of £6m.

The growth shares are valued. Due to the £6m ‘Hurdle’, the value of the growth shares is £10,000 and the manager buys growth shares for this price. Alternatively, the employee may receive the shares for no price and pay income tax on the £10,000 initial market value.

If the company grows in value and is sold for £10m, the value of the manager’s growth shares is 10% of the £4m value above the hurdle, being £400,000. If the company value remains stagnant, or does not grow to exceed the £6m hurdle, the manager gets nothing.

Benefits of growth shares

The participant becomes a shareholder immediately, aligning interests between existing shareholders and participants. In addition:

• Growth shares help preserve the current value for existing shareholders, ensuring that this current value is not diluted.
• The growth in the share value is subject to CGT rules, which are more attractive to employees than income tax treatment that applies to salary and benefits.
• Growth shares can be used with tax-advantaged EMI options, combining their commercial and tax benefits.
• Growth shares are commercially flexible and, when used independently outside of tax advantaged share plans, there is no value cap on growth shares that can be acquired.
• Growth shares can be made forfeitable on employees leaving, with relevant restrictions applying in relation to votes, dividends and other shareholding rights.
• Growth shares form part of the share capital of the company and are therefore governed by the company’s Articles of Association and subject to the same provisions as other shares on the sale of the company including tag and drag provisions.

Who can use Growth shares?

Growth shares are most commonly used by private companies, including start-up companies and private equity backed companies where there are substantial growth prospects.

As growth shares require a new class of shares to be created, they will not generally be appropriate for use directly over shares in UK listed companies. However, growth shares may be created in a subsidiary of a listed company so that, subject to meeting performance targets or vesting conditions, the growth shares can be exchanged for shares in the listed company giving the employees a realisable asset.

For private and listed companies alike, the ability to ring fence the existing value makes the dilutive impact on existing shareholders far less than using ‘normal’ ordinary shares.

Caution needs to be applied to implement growth shares for EIS companies to ensure that the growth shares do not affect the EIS tax reliefs but with care, growth shares can be used by EIS companies.

Tax

On award of the growth shares:

The employee will pay employment income tax on the value of the shares on the date of receipt less any amount paid for the shares. This would require formal valuation input and, depending on share rights, the tax value could be small. Restricted securities tax elections will normally be entered into.

Disposal of the shares:

On disposal, CGT at a rate of 20% should apply to any gain arising to the employees, giving rise to CGT in the example above of £76,800 (after the annual exemption of £6,000 for 2023/24). A tax rate of 10% would apply if the conditions to claim Business Asset Disposal Relief were met.

Corporation tax and accounting

There will usually be no corporate tax deduction available for the costs of the arrangement. Subject to auditor agreement, a growth share plan should result in an FRS 20/IFRS 2 accounting charge based on the fair value of the growth share awards.

Example of tax advantages

The worked example below contrasts a non-tax-advantaged option plan with growth shares and shows that an advantageous employee tax and NIC result can be achieved.

In the share option example, the option exercise price is £0.60 per share and price at vesting is £1 per share. 1m shares are subject to the option.

In the growth share example, a participant acquires 1m growth shares. The rights of the growth shares entitle the holder to participate in the sale proceeds of the company above the current market value of the company of £6 million (ie above £0.60 per share on the basis that there are 10 million shares in issue). The participant is subject to income tax and NIC on the market value of the shares (£10,000, which is equal to the unrestricted market value at the date of acquisition).

In three years’ time, the company is sold for £10 million (£1 per share on the basis that there are still 10 million shares in issue). A holder of the growth shares is entitled to participate in the proceeds between £6 million and £10 million, with the initial £6 million ‘ring fenced’ for the current shareholders.  

	Non-tax-advantaged share options	Growth Shares
Employee
Number of shares under award	1,000,000	1,000,000
Income tax and employee’s NIC on grant @ 47%	Nil	£4,700
Income tax and employee’s NIC on exercise / vest @47%	£188,000	Nil
CGT on sale @ 20%	Nil	£76,800
Total employee tax cost	£188,000	£81,500
New sale proceeds due to employee after funding exercise price and tax	£212,000	£318,500
Employer
Employer’s NIC at 13.8%	£55,200	£1,380
Corporation tax relief @ 18% (on amounts subject to income tax and on employer’s NIC)	(113,800)	(£2,845)
Net employer tax cost	(£58,600)	(£1,465)

*CGT figures include the annual exemption (£6,000 in 2023/24) but no other reliefs.

Other uses of a growth share plan

As well as being used for employment reward and planning, growth shares can be used for effective inheritance and succession.

Instead of awarding growth shares to employees, those shares can be given to family members, directly or through a trust arrangement, for the next generation. This has the effect of transferring all or part of the future growth in the value of the company to other family members, whilst the current generation retain the current value.

The value of the gift will be limited for inheritance tax purposes. This is particularly useful in cases where a shareholding would not qualify for inheritance tax business property relief (such as shares in investment companies).