Employees are key to the growth of a business, and growth shares can be tax efficient and an attractive benefit when looking to recruit. Senior Tax Manager, Connor Smith, is here to explain exactly what growth shares are…
So, what are growth shares?
Growth shares are shares in a company that are generally given to employees. The aim is to ensure that the current value of the company is maintained for the core shareholders, but the subsequent growth is then shared amongst all shareholders.
To give an example, let’s assume a company’s value is £3m. This value will be derived from an independent professional valuation of the company’s activities and is known as the ‘hurdle value’.
The shares owned by the existing shareholders would normally have their rights altered to say that, on sale or liquidation, the first £3m of value is paid to the existing shareholders.
The company would then issue a new, different class of shares to employees that solely have a right to capital. Although sometimes shares may have rights to dividends and votes, more often than not, growth shares only have rights to capital.
When acquiring, the shares have a low value and therefore can be acquired by the employees for either a low price or a low tax charge.
When the company is sold, the amount up to the hurdle value (a proportionate amount of liquidation or sale over and above a specific amount) is paid to the original shareholders. Nothing up to the hurdle value from the sale goes to the growth shareholders, but any remaining value over and above the hurdle value is split amongst all the shareholders evenly.
Let’s take a look at a worked example…
John and Jess are directors of, and are equal shareholders in, XXX Ltd.
John and Jess identify that the future success of the business is somewhat dependant on one of their key employees, Richard.
To reward and retain Richard, he is given 20% of the company in the form of growth shares. The value today is £5m.
Fast forward 6 years, the shareholders of XXX Ltd accept an offer to purchase all of the shares in the company for £10m. The proceeds are then split as follows:
Richard will therefore receive £1m on sale when the original shares cost him little personally.
Although growth shares are a great option to incentivise employees to deliver business growth, schemes should be structured carefully to make sure it’s implemented effectively.
Thinking a growth share scheme could be for you? Here are some points to consider:
- Do the shares have any ‘hope value’ and how would this impact on the initial cost or tax implications?
- Should the scheme be structured so the shares for the employee can qualify for Business Asset Disposal Relief (which can tax a Capital Gain at a flat rate of 10%)?
- Is the business safeguarded if a shareholder employee was to leave?
- Which entity should employee(s) be rewarded in if there is a group of companies?
- What is the current ‘market value’ of the company?
- What are the reporting requirements with HMRC?
Here to guide you
If after reading this, you’re considering a growth share programme for your business and team, it’s important to seek advice. We’ve implemented a number of schemes for clients over the years and would love to support you. To get the ball rolling, please get in touch to arrange an initial meeting with one of our Corporate Tax Team.