Growth shares explained

Growth shares are real shares issued upfront at a hurdle rate. Don't worry, we'll explain what that means and more in this guide. You'll learn what growth shares are, how to use them, who can have them and why they're so effective, particularly for companies with an exit on the horizon.

Contents

1. What are growth shares?
2. How do growth shares work?
3. What are the advantages of using growth shares?
4. What's the difference between growth shares and share options?
5. Growth shares and the Enterprise Investment Scheme
6. Are there any disadvantages to using growth shares?
7. How are growth shares taxed?
8. How to issue growth shares
9. How to set up a growth share scheme
10. Further reading and resources

What are growth shares?

Technically speaking, growth shares are a special class of ordinary shares with limited rights.

What's special about them is that they're effectively worthless until a valuation hurdle is exceeded. What that means is, unlike with plain ordinary shares, the recipient only benefits from the value they help to create above that hurdle.

So companies can reward people for the part they play in growing the business after they joined, not share in the value that was created before they joined. There are a few advantages to this which we'll come onto.

It’s totally legal for anyone to own growth shares in a business - including non-employees. They’re actually one of the most flexible ways to incentivise key people.

Startup Lead, Guy Kaufman, explains:

How do growth shares work?

Growth shares are issued at a hurdle rate, which is usually set at 10-40% higher than the company's current share price.

Recipients only share in the capital growth of the business on anything above the hurdle rate. Open the example below to see how this works in practice. 

The benefits of growth shares

EMI options, unapproved options, and growth shares all come with their own pros and cons (but mainly pros). Let's explore the advantages of growth shares for companies and recipients.

1. Anyone can have growth shares

Growth shares can be issued to employees and non-employees such as accountants, consultants, contractors and freelancers - essentially anyone who contributes to your company's success - including people overseas.

So you can use growth shares to incentivise and reward those who help your business grow even if they're not on the payroll. 

2. Incentivise new shareholders (without alienating existing ones)

Growth shares motivate new shareholders to help grow your business as much as possible because the value of their growth shares is dependent on the business' growth.

And because recipients only share in your company’s capital growth from when they come on board, they don’t dilute the value of the stake your existing shareholders have in your business. 

3. Issue along with (or instead of) EMI options

While an EMI scheme is usually the most tax-advantageous option for businesses and employees, not all are eligible. Growth shares, which are a lot more flexible, can pick up where EMI falls short. 

4. No restrictions

Unlike EMI share options, which are limited to companies of 250 people or fewer (alongside other restrictions), there’s no HMRC restriction on which companies can issue growth shares – or how many people they can issue them to.

5. Issue with or without voting rights

Growth shares can come with full voting rights or none at all. Most companies don’t attach voting rights to their growth shares, but the option is there if it makes sense.

6. Rights to dividends

Growth shares are a good option for scaleups with an exit on the horizon.

But they're an even better option for businesses without an exit in sight because - unlike options - growth shares can have full rights to dividends once they become unconditional (that is when the recipient achieves whatever milestone(s) were set).

So long as the board decides to give dividends to that class of share, and the company's Articles of Association allow it.

The AoA need to outline how growth shares work in relation to other shares. Unlike most AoA out there, the Vestd Articles of Association do just that, so many customers adopt those as it's included in the cost of our price plans.

Alternatively, a lawyer or specialist can modify a company's existing articles, but that could set them back over £10k!

7. Improve retention and drive performance

Business owners use growth shares to spur their teams to do great things. 

Why? Well, studies show that people with even a small piece of the pie are more motivated to succeed and inclined to stick around for longer. It's called the Ownership Effect and it's pretty powerful.

What's more, they can set conditions someone needs to meet in order to receive their growth shares.

If the recipient falls short of those expectations, which are usually time or performance-related, they won’t receive their share or at least not all of it. This protects the business from giving equity to people who don’t deliver on their promises.

We've collected a load of real-world examples you could consider for your conditional growth share scheme. Download the list for free.

Now, let's cover some frequently asked questions.

What's the difference between growth shares and options?

If you give someone options you're giving them the right to buy shares in your company in the future at a pre-agreed price subject to whatever conditions you set.

Option holders don’t become shareholders or receive voting rights or dividends until they actually own the shares. And they do that by exercising them. When that opportunity presents itself is up to you.

Whereas, growth shares are actual shares. So once issued, recipients become shareholders immediately. But that doesn’t mean they can buy and sell those shares straight away - not if you have conditions in place.

Like options, you can design a growth share scheme in such a way that someone effectively earns their shares over time or when they hit specific targets, which is called vesting.

Can growth shares impact EIS eligibility?

It’s a common misconception that growth shares can’t be used alongside the Enterprise Investment Scheme (EIS).

But it’s actually fairly simple to protect your EIS eligibility when using growth shares – the EIS shares just can’t carry any preferential rights. 

We've designed the Vestd Articles of Association so that any ordinary shares issued under EIS do not get a preference regarding dividends or following an exit. So customers don’t need to worry about this one.

Are there any disadvantages to using growth shares?

In terms of disadvantages, there are three things that companies should know before choosing growth shares:

1. You'll need a business valuation each time you issue new growth shares

Like with options, you'll need a business valuation every time you issue growth shares. Only then will you know what hurdle rate to set. The trouble is that business valuations can be expensive.

Unless you’re a Vestd customer on our Standard or Guided plan, in which case, our experts will handle this as part of your subscription.

2. You can't ask HMRC for approval 

Unlike an EMI valuation, a hurdle valuation can’t be approved by HMRC before you issue the shares.

That means HMRC might decide your valuation was too low when they come to review it, leaving your growth shareholders paying Income Tax on the growth shares they’ve received (undoing one of their big benefits).

With this in mind, you should always apply a premium of 10-40% to your shares’ market value when you come to set your hurdle rate to make sure HMRC doesn’t end up deciding that these shares had been undervalued at issue.

But now, armed with this knowledge, you know just what to do, so that shouldn't be a problem!

3. You'll need to amend your Articles of Association

Before issuing growth shares, you need to make sure your AoA are growth share friendly. You ask a qualified professional or specialist firm to do this for you, or save some money and simply adopt the Vestd AoA.

How are growth shares taxed?

Growth shares are worthless at the time of issue, so whoever receives them will face no immediate tax implications.

In other words, they won't pay Income Tax when they receive their growth shares – which means you don’t have to pay PAYE and National Insurance either. 

If they sell the shares later, Capital Gains Tax (CGT) may be payable on any growth in the value of their shares. Typically, 20% CGT but only after you've exceeded your annual tax-free allowance.

Book a call with one of our equity specialists to discuss tax on growth shares in more detail. 

How to issue growth shares

To get started, you’ll first need to:

1. Get permission from your existing shareholders to create a growth share scheme.
2. Update your company’s Articles of Association.
3. Have your company valued, then use that valuation to set your hurdle rate.
4. Determine whether the growth shares are voting or non-voting.
5. Create a growth share agreement for recipients to sign.
6. Allocate your growth shares.

You could turn to an accountant or a specialist and ask them to take care of it. Pay thousands of pounds for the privilege and still have to handle a mountain of paperwork. Or you could join Vestd and issue growth shares with ease... 

How to set up a growth share scheme

If you think growth shares sound right for your business then book a call with our experts today. We’ll help you decide if a growth share scheme is the best option and give you a tour of Vestd too.

If it is, then you can make the most of our innovative scheme designer, fully guided service and five-star support and create your growth share scheme.

Growth share recipients also get access to their own personalised dashboards so they can monitor the value of their growth shares over time.