Growth Shares are a separate class of shares specially created with restricted rights. This means that the shares have a low initial value, and can be bought by an employee at low cost. However, they will become much more valuable as the overall value of the company increases.
The rights and restrictions attached to Growth Shares can be very complex. However, at their simplest, the Growth Shares will benefit from any increase in the value of the company above a set amount or hurdle. The employee typically pays income tax on the initial low value of the shares, with any future increase in value being charged to capital gains tax when the Growth Shares are eventually sold.
Implementing a Growth Share Scheme allows employees to benefit from future growth in the value of the company in a tax efficient way, whilst the existing shareholders keep all of the value in the company at the time the Growth Shares are issued. The other shareholders’ economic interests are diluted but only if the value of the company exceeds the agreed hurdle.
A hurdle is a target valuation chosen by the company (usually on the basis of a valuation exercise carried out by accountants or share valuation experts). If the value of the company remains at or drops below the hurdle, then the value of the Growth Shares remains very low. However, once the value of the company increases above the hurdle, the growth shares become entitled to part or all of that additional value.
Growth Share Schemes issue shares to the employee upfront. Even if the Growth Shares have no voting rights, there will still be situations in which holders of Growth Shares may have to be consulted e.g. if the company is being sold. In addition, if an employee holding Growth Shares leaves it may be necessary to buy the shares back from them.
By contrast, under an option scheme employees don’t become shareholders until they exercise their options. This can be after a specific date or shortly before a company is sold. If an employee leaves any option can lapse, which is far simpler than having to buy back shares. On the other hand, allowing an employee to become a shareholder may make them feel more closely connected to the business, making it more of an incentive to remain in the company.
As Growth Shares need to be a separate share class, new Articles of Association will need to be adopted. These will set out the rights and restrictions of the Growth Shares including:
In addition to adopting new Articles of Association, the company will usually adopt a set of rules regarding how the employees can acquire Growth Shares. This will include a sample invitation letter along with a sample form of acceptance. If non-executive directors or self-employed contractors are also intended to acquire Growth Shares they will need to do so under separate standalone documents.
Unlike some other types of Employee Share Schemes (such as Enterprise Management Incentives or EMI Options) a Growth Share scheme does not benefit from a favourable tax regime. Instead, when an employee acquires a Growth Share they must either pay the full market value of that Growth Share, or pay income tax on the difference between what they pay for that Growth Share and its full market value.
Unfortunately, HM Revenue and Customs ("HMRC") will not agree the value of a Growth Share before it is issued. This highlights the importance of undertaking a proper share valuation exercise and ensuring that the restrictions attached to the Growth Shares in the company’s articles of association are agreed with the valuer. This reduces the risk of HMRC challenging the price paid for the Growth Shares and seeking to charge additional income tax when the Growth Shares are issued.
When the company is sold, the increase in value of the Growth Shares will be subject to capital gains tax at standard rates (currently 18% and 24%) on gains above the employee’s individual annual capital gains tax allowance (currently £3,000). Although the 2024 budget increased capital gains tax rates, these remain considerably below income tax rates.
A company has 1,000 ordinary shares in issue with a nominal value of £1 per share and is valued at £1 million. A new class of Growth Shares is created, with a nominal value of £1 per share, but on the basis that the Growth Shares will only benefit in any increase in value above a hurdle amount contained in the company’s Articles of Association set at £2.5 million. An employee is given the opportunity to subscribe 100 Growth Shares at a price of £2 per share (this is the amount which the company’s valuers believe to represent the current market value of the Growth Shares due to the hurdle and the company’s prospects). The employee therefore pays £200 for the Growth Shares and does not pay any income tax.
Some years later, in January 2025, the company is sold and the net proceeds (after taking account of expenses) available for shareholders are £10 million.
These are divided as follows:
The first £2.5 million is paid to the holders of ordinary shares.
The remaining £7.5 million is divided between all the shareholders (including the employee). The employee receives £681,818 with the remaining monies going to the existing shareholders.
The employee would pay capital gains tax on the difference between the £200 paid to acquire the Growth Shares and the sale proceeds of £681,818, which at the capital gains tax rate in force in February 2025 of 24%, and assuming the employee is a higher rate tax payer who has a full capital gains tax allowance available, would result in a capital gains tax charge of £162,868.32.
If, instead of allowing the employee to buy Growth Shares, a cash bonus of £681,818 was paid at the time of the sale in February 2025, the employee would have to pay income tax at a rate of either 40 or 45% along with the employee’s national insurance contributions at 2%. In addition, the employing company would have to pay employer national insurance contributions of a rate of 13.8 %.
An EMI Option is a tax-advantaged share option under which a company that meets various statutory requirements may issue options to employees up to a maximum initial value of £250,000 per employee. Using Growth Shares may increase the number of shares over which an EMI Option may be granted, and since HMRC will agree the value of shares over which an EMI Option is issued the company and employee will know they have not breached the limit. Business assets disposal relief is currently available to reduce the rate of capital gains tax on the sale of shares acquired under an EMI Option.
THE ABOVE IS INTENDED AS A GENERAL GUIDE ONLY. ALWAYS SEEK LEGAL ADVICE BEFORE ACTING OR RELYING ON THIS INFORMATION.
At Legal Clarity our extensive experience in drafting, establishing, operating and ongoing administration of share option and incentive arrangements for UK companies enables us to offer comprehensive advice and identify whether Growth Shares are the best option for your business.
We’ll work with you to identify why you want to implement Growth Shares and your company goals to understand how you can best benefit from implementing a Growth Share arrangement.
Get in touch with us today for further information, advice and guidance.
