Are growth shares the solution?

17 February 2016

You want staff to feel part of the business, join in the journey of growth and share the ultimate rewards of success. Cash might be difficult in the early years so your alternative is ‘sweat equity’. Or perhaps investors want the key team to have some ‘skin in the game’.

Statutory tax advantaged share plans

Statutory tax advantaged plans (that used to be called approved share plans) enable you to do this and give a range of good tax breaks for employers as well as employees. Even though rules have been relaxed and limits extended in recent years, it can be hard to qualify or the limits on potential rewards are too low to motivate staff.

Unapproved plans deliver economic value but the tax and national insurance liabilities on the taxable benefit received (60.8 per cent for additional rate taxpayers) are a disincentive to all involved.

There is an alternative that can link the upside for the participating staff to company growth, typically on an exit, and reduce the initial value of the award so that it may more realistically fit within statutory limits… 

Growth shares

… ‘growth shares’: sometimes called ‘flowering shares’ or ‘hurdle shares’.

The idea behind this is the creation of a new share class. Initially, the shareholder entitlements on these shares are limited but if the company grows in value (often measured by predetermined growth targets), the shares become more valuable, typically on an exit. Participants, (employees or consultants) receive shares via an option, perhaps an enterprise management incentive (EMI) option, or by gift, perhaps employee shareholder status (ESS) shares, or by a purchase at an affordable price.

Typically the growth targets will be stretching and the growth in value is treated as a capital gain with the usual CGT rates and reliefs, including, for ESS, the potential for a full exemption. 

So what growth targets are chosen by companies?

In practice, this depends on your company and the performance you want to achieve. If, for example, you wouldn’t sell your business for under £20m, then perhaps the growth shares will not have any value unless it is sold for £20m or more, and they might have an enhanced value if the sale proceeds are £30m or more.

There is one snag with growth shares – how much are they worth? On the one hand they have no value until the growth has been achieved. On the other hand, if the growth is achieved there is huge potential value. HMRC may agree values in advance if linked to an EMI or ESS scheme. Otherwise there can be some uncertainty because HMRC announced (at the start of February) the withdrawal of the post-transaction valuation check facility from 31 March 2016. We are still waiting more details, but companies may have to proceed on a 'best estimate' basis.

You might ask – what does HMRC think about growth shares? Well, at the end of last year (2015) HMRC commissioned a research report on growth shares which concluded:

'This research found that growth shares have a definite and important role to play in encouraging the growth of businesses. In the view of some advisers they help to power the wider economy – especially amongst high growth SMEs, with turnovers over £10m – as they are seen as the backbone of the UK economy, creating employment and wealth.'

We agree!

For more information about how growth shares may help your business, please get in touch with Fiona Bell or your usual RSM contact.

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