Growth Shares

Growth share schemes can be a versatile and tax-efficient tool for private companies seeking to incentivise key employees, manage succession, or facilitate inheritance planning. By allowing participants to share in future growth without diluting existing value, growth shares align participants' interests with shareholders and drive performance, and can be an attractive alternative to share options. However, it is essential to implement the scheme correctly in order to ensure the scheme delivers its intended benefits.

What are growth shares?

Growth shares are a special class of shares created by a company to allow selected individuals – typically employees, directors or family members – to participate in the future growth in value of the business above a predetermined threshold, known as the "hurdle". Unlike ordinary shares, growth shares do not entitle the holder to any value in the company below this hurdle. The hurdle is usually set at a premium above the company's market value at the time the growth shares are issued.

For example, if a company is valued at £20 million, growth shares might participate in value only above £24 million. This means that if the company is sold for £30 million, the growth shares would share only in the £6 million of value above the £24 million hurdle.

Growth shares are most commonly used by private companies, including start-ups and private equity-backed businesses, but can also be implemented in subsidiaries of listed companies. They are particularly attractive where traditional tax-advantaged share schemes, such as Enterprise Management Incentive (EMI) options, are unavailable or unsuitable.

How do growth shares work?

The company creates a new class of shares – growth shares – by amending its articles of association. These shares are then issued to selected individuals, who may be required to pay a nominal or market value for them. The rights attached to growth shares are highly flexible and can be tailored to the company's objectives. Growth shares:

• typically participate in the value of the company only above the hurdle;
• may have limited or no voting rights;
• often do not carry rights to dividends;
• are frequently structured to participate in value only on an exit event, such as a sale or IPO; and
• can be subject to vesting conditions, performance targets, and leaver provisions.

Because growth shares have value only if the company grows beyond the hurdle, their initial market value is usually low, making them affordable for employees to acquire.

Tax treatment of growth shares

On acquisition

When an employee acquires growth shares, the tax treatment depends on whether the shares are acquired at market value or at a discount:

If the employee pays the full market value for the growth shares (which is typically low due to the hurdle), there is generally no income tax or National Insurance Contributions (NICs) liability on acquisition.

If the shares are issued at less than market value, the discount is usually treated as employment income and subject to income tax (and possibly NICs) at the time of acquisition.

A formal valuation should be undertaken to determine the market value of the growth shares at the time of issue. HMRC will not agree a valuation for growth shares unless they are used in conjunction with an EMI option scheme, so it is essential for the company to maintain robust records to justify the valuation in the event of a challenge. The valuation of growth shares can be complex, and specialist valuation advice is generally advisable.

On disposal

When the growth shares are eventually sold (typically on an exit event), any gain made is generally subject to capital gains tax (CGT). The gain is calculated as the difference between the sale proceeds and the base cost (the amount paid for the shares plus any amount taxed as income on acquisition).

The main rate of CGT is currently 24%, but a lower rate may apply if the conditions for Business Asset Disposal Relief (BADR, formerly Entrepreneurs' Relief) are met. The BADR rate is set to increase from 14% to 18% from April 2026, but this still offers a differential compared to the main CGT rate which itself is significantly lower than income tax rates.

Importantly, there are no NICs on the increase in value of the growth shares, which is a significant saving for both the employee and the company.

Corporation tax and accounting

Generally, there is no corporation tax deduction available for the costs of a growth share arrangement. However, subject to auditor agreement, a growth share plan may result in an FRS 20/IFRS 2 accounting charge based on the fair value of the growth share awards.

Advantages of growth shares

• Employees become shareholders immediately, incentivising them to drive company growth.

• Growth shares ring-fence the current value of the company for existing shareholders, ensuring that only future growth is shared with new participants.

• Gains on growth shares are subject to CGT rather than income tax, which is generally more favourable, especially for higher-rate taxpayers. There are also no NICs on the growth in value.

• Because growth shares only have value if the company grows, their initial market value is low, making them affordable for employees to acquire.

• The rights attached to growth shares can be tailored to suit the company's objectives, including vesting schedules, performance conditions, and leaver provisions.

• Unlike EMI options, which must be exercised within 10 years, growth shares do not expire, making them suitable for companies that do not anticipate an exit in the near to medium term.

• Growth shares are not limited to employees and can be used for inheritance and succession planning, allowing future growth to be passed to family members while preserving existing value for the current generation.

Pitfalls and issues to avoid

• Employees must pay for the growth shares at the time of issuance. If they do not pay full market value, they will incur an income tax (and possibly NICs) charge on the discount.

• HMRC won't agree to a valuation for growth shares (unless used with EMI options), so companies must undertake a robust, defensible valuation each time growth shares are issued. If HMRC later deems the valuation too low, there is a risk of additional income tax and NICs liabilities.

• Implementing a growth share scheme requires amending the company's articles of association, obtaining shareholder approval, and preparing detailed legal documentation. Companies need to factor in this process and the associated adviser costs.

• While growth shares do not dilute existing shareholders' interest in the current value of the company, they do dilute their interest in future growth.

• Growth shares have the potential to prejudice SEIS/EIS relief, and so care must be taken to implement them in a way which preserves any such relief

• The favourable tax treatment of growth shares depends on current legislation. Changes in tax law could affect the attractiveness of growth shares in the future.

• Careful thought must be given to what happens if a holder of growth shares leaves the business. Leaver provisions should distinguish between "good leavers" and "bad leavers" and set out the consequences for each.

Steps to implement a growth share scheme

If you conclude that a growth share scheme is suitable for your business, you will need to work through the following key steps:

1. Decide on the rights to attach to the growth shares, including voting, dividends, vesting, performance conditions, and leaver provisions.

Note: Specialist legal and tax advice is recommended to ensure the growth shares are structured properly to meet your requirements and achieve tax efficiency, and ensure you understand the implications for the company and participants.

2. Value the business to determine the appropriate hurdle for the growth shares and value the growth shares, to set the purchase price and determine the tax treatment.

Note: Expert valuation advice is generally recommended.

3. Draft and adopt amendments to the company's articles of association to create the new class of growth shares and relevant provisions, including leaver provisions.

Note: Ensure the final draft is shared with the valuation advisers to ensure alignment.

4. Obtain the necessary shareholder resolutions to approve the new articles and the issue of the growth shares.

5. Prepare growth share subscription agreements, along with accompanying communications and guidance for participants.

Note: Participants will need to understand the scheme and its risks. However companies should take care to avoid giving tax, legal or financial advice.

6. Invite selected individuals to subscribe for the growth shares, ensuring payment is made by the participants for the shares or income tax is accounted for if shares are issued at a discount.

7. Make applicable restricted securities tax elections (such as a section 431 election) to ensure the correct tax treatment, even if only on a precautionary basis.

8. Report the issue of the growth shares to HMRC in the company's annual share scheme return by 6 July following the end of the tax year in which the shares were issued.

9. Maintain accurate records, monitor compliance with the scheme terms, and review the scheme as the company grows or circumstances change.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.