It’s an exciting time when a startup reaches the scaleup stage. Typically, at this point, the team is growing, and the future looks promising. But how do business owners capitalise on that success?
Incentivising the team is one sure-fire way of driving the business forward. And share and option schemes are a great way to incentivise employees.
Proven to boost engagement, productivity and performance, share schemes inspire teams to contribute their very best to the business, as they have a vested interest (literally).
But what share schemes work best for scaleups? There are different share/option schemes to suit different business needs. Scaleups with strong growth prospects and an exit plan may be interested in Growth Shares.
We’ll delve into why that is, but first, we’ll briefly explain what Growth Shares are, how they work, when to use Growth Shares and how to start issuing Growth Shares.
What are Growth Shares?
Growth Shares are real shares, issued upfront, at a hurdle rate (we’ll come on to that shortly). Technically speaking, a special class of Ordinary Shares with limited rights.
So, when it's time to sell the business, recipients only receive a share in the value above a certain threshold. We call that the hurdle rate.
A hurdle rate is a small premium (10-30%) above the current value of a company per share. Once a company’s value exceeds this premium, the recipient can share in the future growth of the company, above the hurdle rate.
How do Growth Shares work?
As Growth Shares are issued at a hurdle rate, a recipient’s share in the capital growth of the business is from the point the shares are issued, not the company’s inception.
Essentially, reflecting the value that the recipient adds to the business from that point onwards.
Growth Shares can be conditional, so long as the company's Articles of Association have been drafted to enable this. For instance, the recipient may have to meet a performance-based milestone, and until they do, they can't realise the full potential of the shares.
Subject to board discretion, recipients have full rights to dividends once the Growth Shares have become unconditional (when the recipient has met the criteria).
Growth Shares are ideal for incentivising new starters while protecting existing shareholders (often the founders and core team members) from dilution. How so?
When to use Growth Shares
To protect existing shareholders from dilution
As recipients only receive a share in the capital growth of the business from the point the shares are issued, existing shareholders are only value diluted for growth from that point onwards.
Dilution is when a shareholder’s proportion of equity dilutes because additional equity is issued. Though, dilution is not as scary as it sounds. In fact, share dilution isn't necessarily a bad thing.
Nevertheless, with Growth Shares, owners of scaling businesses can reassure shareholders by mitigating the dilution of the existing value of the business.
There is an exit plan
Typically, recipients of Growth Shares only realise the full potential of their shares on an exit. So, high growth companies with a good exit strategy can use Growth Shares to incentivise their team to work towards that eventuality.
Because when that moment comes, they get to share in the capital profits on the sale (providing that the business is successful). So, everybody wins with a well-earned slice of the action.
As an alternative to HMRC-approved schemes
HMRC-approved schemes (ESS) like Enterprise Management Incentives (EMI) are an attractive option. EMI, in particular, offers enviable tax advantages that benefit both the employer and employee.
However, the criteria for EMI is quite strict; not all businesses or employees are eligible. Growth Shares are often seen as a flexible alternative. Especially because Growth Shares have tax benefits of their own...
Recipients pay no Income Tax on exercise. And if they sell the shares later, they only pay Capital Gains Tax on the difference between the hurdle and the eventual sale price.
Some scaleups eligible for EMI opt for both EMI and Growth Shares. This combined approach is usually because business owners want to reward non-employees in addition to employees.
To incentivise and reward non-employees
Growth Shares are used to incentivise employees and non-employees like (but not limited to):
- Non-executive directors
And so on. Essentially, anybody who contributes to the success of the business. Not just employees on the payroll.
Instead of Ordinary Shares
Ordinary shares are exactly that, ‘ordinary’. Issued without any strings attached, recipients of Ordinary Shares become shareholders immediately. Often with voting rights and, in some cases, dividends.
For scaleups, giving away Ordinary Shares could be an unnecessary risk. What if the recipient doesn’t deliver as promised yet still walks away with a stake in the business?
Conditional Growth Shares mitigate that risk, ensuring that recipients only profit if they live up to their promises.
Not only that, but sometimes Ordinary Shares are too expensive for employees (or non-employees) to buy. Growth Shares are more accessible in that regard.
How to issue Growth Shares
With all that in mind, it’s clear to see why Growth Shares are an attractive proposition for scaleups. But how do business owners set about issuing Growth Shares?
Traditionally, business owners enlist accountants and lawyers to take care of everything. And still find themselves swimming in a sea of paperwork.
Vestd is a digital equity management platform that helps to streamline the whole process.
On Vestd, recipients have access to a dynamic online dashboard. It keeps their shares front of mind, instead of relying on pieces of paper stashed away in a drawer somewhere.
If you’re scaling up and Growth Shares sound appealing, book a free consultation with one of our equity specialists to find out more.