Growth shares: the flexible way to share success

Sharing ownership with your team can be a superb way to align interests, incentivise performance and build a culture of shared success. 

It's a way to turn employees into partners, invested not just in their own roles but in the overall health and growth of the business.

But with so many different types of equity compensation out there, knowing exactly what equity-sharing strategy to turn to is tricky. 

One option gaining traction among companies is growth shares, and they might be a great fit for your business. 

But what really are growth shares, and how exactly do they work? Read on, and we’ll reveal all. 

What are growth shares?

Also called ‘hurdle shares’ or ‘flowering shares’, growth shares are a special class of ordinary shares that allow recipients to benefit from the future growth in your company's value.

What sets them apart from typical ordinary shares is that they have limited rights.

Specifically, they only start to have value once your company reaches a certain valuation threshold, known as a "hurdle".

Growth shares in action

Here's how it works in practice:

• Let's say your company is currently valued at £10 per share.
• You decide to issue growth shares to key team members with a hurdle of £15 per share. 
• The difference between the current share price (£10) and the hurdle price (£15) is known as the "hope value".
• This "hope value" reflects a 40% premium on the current market value, which helps mitigate the risk of HMRC determining that the growth shares were undervalued on issue.
• What this also means is that the growth shares will only start to have value once your company's share price exceeds £15.
• Any growth in value beyond that £15 hurdle is then shared between the growth shareholders and your existing shareholders.
• The key to growth shares is that the value that existed before the growth shares were issued (up to £10 per share in this example) is protected. It belongs solely to your existing shareholders.

AND as the growth shares have no real market value and are worthless at the time of issue, recipients only have to pay nominal value for the shares which, if set up correctly, is less than pennies. 

Growth shares vs other types of equity

So how do growth shares stack up against other common types of equity compensation? Let's take a look at two comparisons with ordinary shares and options:

Growth shares vs ordinary shares

The key difference here is that plain old ordinary shares immediately dilute existing shareholders, while growth shares only dilute future growth.

With ordinary shares, if you give away 10%, your existing shareholders immediately own 10% less of the company.

But growth shares, as we said, are a special class of ordinary shares, so instead, existing shareholders keep all of the current value and only share in future growth above the hurdle.

Growth shares vs options

Share options give the holder the right to buy shares at a set price at some point in the future. They can be an excellent way to incentivise team members but come with a few limitations.

EMI options, for example, can only be given to employees on the payroll in UK-based companies, and there are limits on the total value of options you can issue.

Growth shares, on the other hand, can be given to anyone – employees, advisors, consultants, you name it. And there are no statutory limits on the value of growth shares you can issue.

Another difference is that with options, the recipient doesn't actually own any shares until they exercise their option.

With growth shares, they become shareholders from day one, although the economic value of their shares is tied to the hurdle.

Growing popularity?

So why are more and more companies turning to growth shares? Well, it has a lot to do with their simplicity and flexibility, especially for established businesses with substantial valuations.

Take Boohoo, for example. The online fashion retailer has a market cap of over £1 billion, even after a challenging year that saw losses widen to £160 million and net debt climb to £95 million.

In this context, traditional stock options or restricted shares might not provide enough incentive for top executives. Enter growth shares.

Boohoo's plan, narrowly approved by shareholders last year, offers a maximum payout of £175 million if the company's share price hits 395p and maintains that level for 90 days within five years. For CEO John Lyttle, that could mean a staggering £50 million payday.

The beauty of this structure is its simplicity. The value is tied directly to share price appreciation, aligning executives' interests with those of shareholders. It's also flexible: the targets and time horizons can be customised to suit Boohoo's specific situation and goals.

Of course, there are caveats. Some shareholders baulked at Boohoo's generosity in its awards, especially in light of recent performance. The company had to backtrack on £1 million one-off bonuses proposed for three executives. Clearly, growth shares aren't a panacea.

Nevertheless, growth shares offer a straightforward way to motivate leaders for businesses like Boohoo, with substantial valuations and fierce competition for talent.

The upside is huge if targets are hit. No wonder more and more companies are embracing this model to try to achieve ambitious growth targets, despite the occasional controversy.

Do you pay tax on growth shares?

Yes is the short answer. When and how much depends on a few factors.

As long as the hurdle is set at a reasonable premium (typically 10-40%) above the current market value, no Income Tax or National Insurance is due on the receipt of the shares.

But when the shares are sold, the recipient has to pay Capital Gains Tax on any gains. It's probably best explained with a couple of scenarios:

• Scenario 1: The company performs well and is sold at £10 per share.

The hurdle was £7 per share, so the growth shares participate in the increase in value above £7.

The growth in value per share is £3 (£10 sale price - £7 hurdle).
For their 1,000 growth shares, the recipient receives a payout of £3,000 (1,000 shares * £3 growth per share).

The recipient will need to pay Capital Gains Tax (CGT) on the £2,900 gain (£3,000 payout – £100 purchase price or taxed benefit value).

• Scenario 2: The company underperforms and is sold at £6 per share.

The sale price is below the £7 per share hurdle, so the growth shares do not participate in any value. The growth shares are worthless and will lapse. There are no tax implications for the recipient in this scenario, as there was no gain.

It’s worth noting that HMRC doesn’t offer the option to pre-approve a valuation for a growth share scheme, which means there's always a degree of uncertainty.

In the event that HMRC says the shares were undervalued at the time of issue, they may levy Income Tax on the difference between the hurdle price and the market price they determine to be correct.

As ever, if you're in any doubt, consult a tax professional.

Setting up a growth share scheme

The key steps are:

1. Valuation: You'll need a current valuation of your company to confidently set the hurdle price for the growth shares. We provide valuations with all of our share scheme plans.
2. Shareholder approval: Your existing shareholders will need to approve the creation of a new class of growth shares.
3. Scheme design: You'll need to decide on the key terms of your growth share scheme – the hurdle price, the vesting conditions, the shareholder rights, and so on.
4. Legals: You'll need to update your Articles of Association to create the new class of growth shares and establish growth share agreements for each recipient. (Many of our customers adopt the Vestd Articles when they join which covers growth shares).
5. Issuing the shares: Once all the paperwork is in place, you can issue the growth shares to your chosen recipients.

It might seem like a lot, but with the right support, setting up a growth share scheme can be a straightforward process. 

Is a growth share scheme right for your company?

If you're very early stage and haven't hit product-market fit yet, the focus might be more on pure alignment than protecting existing value. In that case, ordinary shares or options might be more appropriate.

On the other hand, if you're a larger, more mature company, you might have more complex needs that require a bespoke scheme design or multiple.

With that said:

Growth shares are a powerful tool for many startups and scaleups, particularly those with significant existing value that they want to protect.

They offer a flexible, tax-efficient way to incentivise and reward a broad range of brilliant individuals without excessively diluting existing shareholders.

The key is to get the design right - and that's where our platform shines.

Growth shares made easy

Design a growth share scheme that meets your specific needs, from the hurdle price to the vesting conditions, on Vestd.

You can also use the Vestd Articles of Association for free if your articles lack the right provisions for growth shares.

Once your shares are issued, our platform makes ongoing management a breeze.

Recipients can view their holdings, understand their vesting schedules, and even exercise their shares when the time comes – all through their personal Vestd dashboard.

The result? You get all the benefits of a growth share scheme, without the headache of trying to manage it manually.

So, if you're ready to explore the potential of growth shares, get in touch.

Book a call