In a highly competitive market for talent, many companies are keen to adopt alternative methods of motivating, incentivising and retaining key individuals; those whom they see as mission critical to the growth of their company. Over and above the standard remuneration and benefit packages there are equity solutions available which can demonstrate an employer-based commitment to key members of the company.

Whilst Enterprise Management Incentive (EMI) share option plans remain the equity plan of choice, many companies do not meet the qualifying criteria for various reasons such as size, ownership structure and the industry the operate in. An increasingly popular solution for such companies is Growth shares.  

What are Growth shares?

They are shares which allow the employee(s) to benefit in the growth in equity value of the company above an agreed equity value (the “hurdle”). The equity value of existing shareholders is protected by ensuring the current value of the company is ringfenced.

A simple example would be a company with 1,000 shares where the estimated equity value is £10,000,000 at the date of issue of 100 Growth shares. A hurdle is set which means the employee(s) can only participate in equity when the value exceeds £15,000,000. On a sale of the company for £18,000,000, the existing shareholders (holding the 1,000 shares) would share the first £15,000,000, protecting their existing share value. Between £15,000,000 and £18,000,000, the growth shareholders participate pro-rata with the existing shareholders.

There can be some flexibility in terms of other rights attached to Growth shares, and we have seen examples where growth shares may have the same voting and dividend rights as other shareholders (perhaps allowing for Entrepreneurs’ Relief to be available), and others where there are limited rights. As with any such share plan, it is important that legal and tax advice is taken to ensure the intended structure is implemented as intended.

What about valuation?

The hurdle will likely have a fundamental impact on the tax valuation at the date of issue of the Growth shares. HMRC do not agree tax valuations for Growth shares, therefore it is fundamental to ensure that the tax valuation methodology used is robustly tested and documented to ensure any future challenge from HMRC or a diligence provider can be managed appropriately.

What are the key tax implications?

Under a classic Growth share structure, the tax valuation at the date of issue will typically be low, given the hurdle inserted – assuming that the hurdle is sufficiently challenging/stretching. So long as the employee pays the unrestricted market value for the Growth shares, no income tax should arise on acquisition. From the date of shares being issued, any growth in value should be subject to capital gains tax where the shares are sold to an un unconnected third-party purchaser, which based on rates today is currently 20%. Where the qualifying conditions for Entrepreneurs’ relief are met the capital gains tax rate should be reduced to 10%.

The company has obtained SEIS/EIS investment – is there anything I should be thinking about?

Where a company has taken SEIS/EIS investment there can be additional complexities. The implementation of a Growth share scheme may be possible, but very careful drafting of the Articles of Association/Shareholders Agreements is required to ensure no nasty surprises at a later date.

Can EMI options be granted over growth shares?

Yes, an EMI option can be granted over a Growth share, so long as the company and employee EMI qualifying conditions are satisfied.

Johnston Carmichael’s Entrepreneurial Taxes team have worked with a wide range of companies to implement employee incentives plans; including EMI, CSOP & Growth shares. We have expertise in tax valuation work, scheme design and implementation, working with HMRC’s Enterprise Centre to ensure that SEIS/EIS status is protected, and working with clients to ensure that we deliver the type of scheme that works for their company. 

Please contact Max Chassels to discuss which type of share option plan might be suitable for your company.