Want to keep key people? Growth Shares might be the answer

Want to keep key people? Growth Shares might be the answer

Growth Shares or share options
Growth Shares or Share options?

You’ve found a superstar who you know will be instrumental in your company’s future growth.

You want to keep them on board and incentivise them to help grow the business.

A typical strategy here would be to offer them something like employee management incentives (EMIs) – a form of share option.

But what if your industry is excluded from providing these, like in hospitality? You might find that Growth Shares are the alternative you need to explore.

What is the difference between growth shares and ordinary shares?

You discussed EMIs, but your hotel business isn’t eligible. Share options seem like the next best thing, offering the employee the chance to buy shares at a future date, often when the company is sold. Sounds great, especially since they don’t need to shell out any cash upfront. This is because often the shares are ‘exit only’ shares, meaning that the sales of the shares can happen at the same time when the company is sold. 

However, with unapproved share options, any gains get taxed as income tax, not the more favourable capital gains tax (CGT). Not ideal.

Growth Shares Blossom!

Growth shares are a clever strategy when share options aren’t an option. They incentivise your key employee by letting them share in the company’s future growth, but with a twist. These special shares only kick in when a certain target (or hurdle) is met, usually when the company is sold for a specific amount. Setting the hurdle at a certain level allows you to plan the value of what an eventual sale would look like. It’s great to form a position on this, so each year, you can keep on track, unlocking further value in your business.

They offer

  • Flexibility: Unlike EMI or CSOP, growth shares work in any industry and there are no limits on the number issued or who receives them.
  • Tax Efficiency: Growth shares are taxed as capital gains, not income tax, when the hurdle is met
  • Affordable Entry: Since the shares have no value until the hurdle is reached, your employee can afford to buy them outright.

Here’s an example

  • Your company is currently valued at £1.5 million.
  • You want to offer your sales manager 10% of the company through growth shares.
  • You can’t just transfer shares to them because this would have severe tax consequences (even if you did gift relief!).
  • You set the hurdle target at a sale exceeding £1.5 million. You will often find that you will need to set the hurdle at something higher than the value of your business currently. This is to satisfy the fact that there is currently no value in the shares being offered and that this position is accepted by HMRC. 

If the company sells for £3.5 million:

  • The owner gets the first £1.5 million.
  • The sales manager gets 10% of the remaining £2 million, which is £200,000 – the same as with unapproved share options, but taxed at a lower rate.

Things to Remember

  • Valuation: Growth shares are initially cheap because they only pay out after the hurdle. You will need to get a professional valuation completed to ensure – don’t cut corners!

  • Hope Value: HMRC might argue a high hurdle has “hope value,” meaning the shares might be worth more than their face value. This could lead to some income tax being due. Avoid this by setting a hurdle slightly higher than the current business value.

  • Restricted Securities: Growth shares often come with restrictions, which can trigger income tax when sold.

Bonus tip

To maximise the CGT benefit, it can be advisable to do a joint election with your manager within 14 days of issuing the shares. This ensures they’re taxed on the full unrestricted value from the start.

Growth shares offer a flexible and tax-efficient way to keep your top talent motivated and invested in your company’s success. So, if traditional share options aren’t the answer, consider growth shares – they might just be the key to unlocking long-term growth for both your business and your star employee.

Reward key people
Consider incentivising the whole team with EOT's

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