Growth Shares, the sensible incentive.
The key aims of the Growth Shares concept is to ensure that:
- the new shares to be issued to the managers/senior employees are either worthless or worth very little at the date they are issued. This is primarily in order to prevent any benefit-in-kind type charges arising on the immediate or subsequent issue of the shares in question; and
- the existing shareholders ‘bank’ the current value of the company.
In order to achieve this aim, the company will be valued on or around the date of issue of the new class of shares to managers/senior employees. This new class of shares shall be referred to as ‘Growth Shares’ whereas the current class of shares will be referred to as the ‘Existing Shares’.
The company’s accountants will need to carry out a valuation of the company in order to ascertain its entire capital value, including the hope and expectations of any future increase in value. This value will then be allocated to the Existing Shares. If the entire value of the company is allocated to the Existing Shares, it will render the Growth Shares worthless at the date of issue.
Value attributable to an Income Stream
If the company has a history of paying dividends on the Existing Shares, HMRC may, in addition to the capital value outlined above, claim that there is a legitimate expectation of dividends being declared on the Growth Shares. An income stream is a valuable right which would give the shares to which it is attached value as at the date of issue.
If dividends are paid regularly on Existing Shares, we will need to consider, together with your tax advisers, whether any additional restrictions on the payment of dividends on the Growth Shares would be helpful in order to reduce their value.
A simple method of ensuring this is to remove the right of the Growth Shares to receive a dividend although this would reduce the tax benefits of declaring dividends (rather than paying bonuses in due course).
Articles of Association
In order to implement the above, new Articles of Association for the company will need to be drafted to:
- allocate the entire current value of the company to the Existing Share (and therefore to the existing shareholders); and
- ensure that any growth in value of the company is allocated between the Existing Shares and the Growth shares on a pro-rate basis.
The Growth Shares can then be issued to the managers/senior employees who will participate in the future growth of the company (e.g. an aggregate of 20-30% of the entire shareholding).
By way of example, if it is assumed that the company is:
- currently worth £10 million; and
- later sold for £20 million,
the Existing Shares would be sold for £10 million. The Growth Shares will also be sold for £10 million with the managers/senior employees receiving 20-30% of the increase in value (i.e. £2-3 million) with the current shareholders receiving the remaining £17-18 million.
Whilst the above is the standard way to structure the concept, there are some potential variations:
- The Growth Shares ‘kicking-in’ at a value higher than the current value of the company.
This would not be problematic as it will be easier for the tax advisers to establish that the shares are worthless on the date of issue.
- Placing a ‘ceiling’ on the Growth Shares.
This is effected by amending the rights of the Growth Shares in the company’s Articles of Association (e.g. by stating that the Growth Shares only participate in sale proceeds between £10 and £20 million).
Unless the Growth Shares are issued via an EMI Option arrangement, the managers/senior employees will not qualify for Entrepreneurs Relief unless they hold at least 5% of the share capital.
An EMI Option is useful if there is a preference for the shares to be issued in the future or if certain targets are to be met prior to the issue of the shares. These targets could be as simple as requiring an individual to still remain with the company after a certain period of time (e.g. two/three years) and/or if turnover/profit reaches a certain amount per year.
THIS PAPER IS INTENDED AS A GENERAL GUIDE ONLY. ALWAYS SEEK LEGAL ADVICE BEFORE ACTING OR RELYING ON THIS INFORMATION.
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