Hurdle rates and valuations

The first step to setting up a Growth Share scheme.

What is a hurdle rate and how is it set?

You will need to set a hurdle rate for your Growth Shares before you can set up a Growth Share scheme on the platform.

A hurdle rate is the level, in £ per share, above which the beneficial owner of that share will have full economic rights to the company in question. 

For example, let's say your company is currently valued at £1 per share and you want to issue growth shares to a new employee. 

Hurdle rates often carry a small premium to reflect the hope value of the shares - so in this instance it could be set at £1.20.

The hurdle rate quite literally acts as a hurdle the recipient must overcome for their shares to carry value, and it incentives them to help the company grow, as any value above their hurdle is theirs to keep. 

A few years later, the company has grown and is eventually sold for £5 per share. The recipient is rewarded for their hard work and takes home the amount above their hurdle - in this case, £3.80 per share. 

Ordinary shareholders will participate in the full amount of the sale.

Growth shares and hurdle rate are not just an incentive for growth, but also protect existing shareholders from dilution and simultaneously respect the work they've put in to grow the business thus far. 

As the company grows, hurdles can increase. Using the example above, if another employee joined a year later, their hurdle could reflect the current share price plus a small premium - let's say £2.20. 

When recipients receive their growth shares, they shouldn't incur a tax liability as the growth shares are essentially worthless at the time of issue. 

They will only need to pay Capital Gains Tax on the eventual sale of the shares - based on the difference between the eventual share price and their hurdle rate.

How do I get a hurdle valuation?

Unlike an EMI valuation, a hurdle valuation cannot be approved by HMRC before issuing the shares. But HMRC may retrospectively review a hurdle valuation if they deem it too low (we explain what happens in this scenario below).  

Instead, a 'self-assessed' valuation for the current value of the shares is set, and a small premium is then applied to reach the hurdle. This valuation is then kept on record.

Because it cannot be approved by HMRC, a hurdle valuation will need to be more conservative (a little higher) than an EMI valuation, to make sure there are no nasty surprises down the line.

Other than this factor, and some slight differences in the format of the report itself, the valuation process is largely the same as it is for EMI.

You can request a hurdle valuation through the Vestd platform by going to Share schemes > Valuations via your side navigation, then click New valuation > Start a new valuation to begin. 

Select that it's a growth share valuation you're after, then you'll be asked a series of questions about your company which allows our Valuations team to create your hurdle valuation. 

Once you approve our hurdle valuation, the next step will be to adopt the Vestd Articles of Association or add the Growth Share clauses to your existing Articles

Then you can create your growth share scheme! 

What happens if HMRC audit my hurdle valuation? 

While hurdle valuations aren't HMRC-approved before growth shares are issued, HMRC may decide to retrospectively audit a company if they deem the hurdle too low. They would find this out when an annual notification is submitted for the growth shares. 

We often refer to growth shares as being worthless on issue due to the fact that the hurdle rate is set above the current market value of the shares.

This means the growth shares are issued 'out of the money' and therefore the recipient doesn't incur a tax liability. This is one of the key benefits of growth shares.

However, if HMRC deems the hurdle too low, they would see the growth shares as being 'in the money' on issue.

In this scenario, they would charge the recipient income tax on the difference between the hurdle and their determined market price at the time of issue. 

Our Valuations team avoid setting the hurdle too low for this very reason. If HMRC were to retrospectively audit your hurdle valuation, your growth share recipients could be hit with a large tax bill. Learn more about how the hurdle affects growth share tax

 

Our team, content and app can help you make informed decisions. However, any guidance and support should not be considered as 'legal or financial advice'.