Growth shares are a class of shares that reward recipients for the value they add to the company from the point at which the shares are issued.
Growth shares are issued with a ‘hurdle’ which is the point at which the shares become valuable to the shareholder. The hurdle is usually set 10-40% above the current market value of the shares, and this acts as a figurative hurdle the shareholder must overcome for their shares to be ‘in the money.’
In other words, the hurdle rate is the starting point at which growth shares become valuable. When the company's share price reaches the hurdle, any gain from that point on is profit.
Setting the hurdle above the current market value also safeguards the recipient from incurring a tax liability on receipt of the growth shares, because their shares are issued ‘out of the money.’ So the only tax liability you will incur is Capital Gains Tax on any gains when the growth shares are sold.
Now you may be wondering why you don’t get to keep any amount below your hurdle.
Hurdles – and growth shares in general – are designed to reward people for the growth in value they add to the company after they join, not before. This also helps protect existing shareholders from dilution while respecting the work they have done to grow the company to the point of the hurdle. Fair enough, right?
But one benefit that’s sometimes forgotten about with growth shares is that any gain is virtually all profit, as you only pay nominal value for the shares upon acceptance. In other words, you’re buying shares in an established company for next to nothing.
For example, an ordinary shareholder purchases 10,000 shares in Acme Ltd, which has a market value of £1 per share. Acme Ltd issues an employee 10,000 growth shares with a hurdle of £1.20 per share.
In 4 years' time, Acme Ltd is sold for £3 per share. The ordinary shareholder enjoys a £20,000 profit, whereas the employee profits £18,000.
The profit isn’t too different, but the upfront capital is. The ordinary shareholder paid £10,000 for their shares, whereas the employee only paid nominal value for theirs – which is usually £0.000001 per share (£0.000001 x 10,000 = £0.01).
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