Growth shares: incentivising key individuals to remain and contribute to long-term growth
While growth shares can qualify under EMI share scheme rules, they can also be a tax-efficient incentive option for businesses that do not qualify for EMI. Management incentives that are designed well can help recruit and retain key people who can benefit from the equity growth of the business.
What are growth shares?
Growth shares are a special class of share which enable key individuals to participate in the value of a company above one or multiple enterprise or equity hurdle rates. Hurdles are typically set at a premium above the current market value of the company or enterprise at the point when the growth shares are issued.
Because growth shares typically participate in equity only after the hurdle(s) have been met, their initial market value is often lower than that of the current ordinary shares in the company. As a result, the value of pre-existing equity attributable to the ordinary shares is typically ringfenced, thus preserving their economic interests whilst incentivising new equity holders.
Why is a valuation important?
Several factors must be considered to ensure an issue of growth shares is successful and equitable for both the current shareholders and the new growth share recipients.
To ensure tax compliance, we recommend getting a fair independent assessment of market value before issuing the growth shares. This ensures that the company and the recipients of the shares are fully informed about the potential tax consequences that may arise in the event that the issue price is subsequently considered to be markedly different from market value.
The success of an issue of growth shares is also heavily reliant on the correct setting of hurdle(s). This helps to ensure that the recipients remain aligned and engaged, whilst also ensuring the future returns of existing shareholders are not too significantly diluted.
To meet these success factors, financial modelling that is specific to the company is usually needed. To consider the wider economic and industry specific factors facing the business, sensible growth and margin predictions are needed using various third-party sources. Additionally, the time value of money and the level of risk associated with issue of growth shares must be factored in.
The integrity of any valuation within the fiscal rules also depends on the level of information that would be hypothetically available to a third-party purchaser. This level of information would normally be determined by the size of the shareholding being valued, as well as the amount of influence that the shareholding would attract.
What are the tax consequences?
Provided the recipients of the growth shares pay full market value, there should be no income tax or employee NI contributions payable, nor should there be any employer NI contributions payable. If the recipient pays less than the market value for the shares, they have to pay income tax and, in some circumstances, employee NI contribution on the difference between what they paid and the market value. If a NI liability arises, it will include an employer NI contribution as well.
On a disposal of the shares, capital gains tax may be payable at a rate of 20% between the market value at issue and the disposal proceeds. However, the recipient should be able to utilise any unused capital gains tax annual exemption in the relevant year; as well as potentially being eligible for business asset disposal relief at rate of 10% if certain conditions are met.
For a detailed overview of the tax considerations specific to your circumstances, our business and corporate tax team will be able to assist.
How can Moore Kingston Smith help?
When considering an issue of growth shares, we recommended getting help from a valuation expert. At Moore Kingston Smith, we have a specialist valuations team highly skilled in advising on and valuing growth shares.
Whether you need help determining if an issue of growth shares is suitable, or if you require an independent market value assessment, Moore Kingston Smith’s business valuation services can help you.
Get in touch with our team.