Understanding how your growth share hurdle works and the reasons for it.
The hurdle rate is the starting point at which growth shares become valuable. When the company's share price reaches your hurdle, any gain from that point on is profit.
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, growth share recipients must help the company grow for their shares to become valuable.
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.
For example, a company with a share price of £1 per share may issue 1,000 growth shares to a recipient with a hurdle of £1.20 per share, and a 4-year vesting schedule with a 12-month cliff. 25% of the shares vest each year after the cliff.
Now, the growth share recipient is incentivised to not only stay with the company to earn their shares, but to also help the company grow. The recipient delivers and the company’s share price increases each year.
By year 5, the company is worth £5 per share – but the recipient’s growth shares are effectively worth £3.80 per share as they don’t participate in any value below the 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?
On a final note, it’s worth adding that if more growth shares were issued in year 5 for example, the hurdle rate would be 10-40% above the current price of £5 per share. Again, this protects our original growth share recipient from dilution while respecting the work they have done to get the company to £5 per share.
Your dashboard and agreement summary will show your growth share hurdle rate and vesting schedule.
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