Growth Shares

Growth shares are a commonly used way of structuring an equity interest in a company. They are designed so that the holder participates only in future growth in the value of the company, rather than the value already built up by existing shareholders.

This is typically achieved by creating a separate class of shares with rights that only allow participation in value above a specified threshold. Because the shares do not benefit from the company’s existing value, their market value at the time they are issued is usually lower than that of ordinary shares.

Growth shares are often used where the aim is to align incentives with future performance, while preserving the historic value of the business for existing shareholders.

The defining feature of a growth share is the presence of a hurdle.

The hurdle represents a level of company value that must be exceeded before the growth shares participate in value. Existing shareholders retain the value of the company up to the hurdle amount, while the growth shares participate only in value created above that level.

In practice this means:

✨ growth shares participate only in future increases in value

✨ they often have limited value when first issued

✨ they often realise value primarily on a capital event

This structure effectively ring-fences the value already built up in the business and allocates only future growth to the new share class.

Rights attaching to growth shares

The rights attached to growth shares are determined by the company’s articles of association and any relevant shareholder agreements.

These rights can be tailored to suit the commercial objectives of the arrangement. Common features include:

📈 Participation above a hurdle

The shares only receive value once the company value exceeds a specified level.

💰 Limited dividend rights

Growth shares may not receive dividends until the hurdle has been exceeded.

🗳 Restricted voting rights

In some cases voting rights are limited or removed altogether.

🚪 Transfer restrictions

The shares may be subject to restrictions on transfer or compulsory transfer provisions.

In many cases growth shares are structured so that they deliver value primarily on a liquidity event, such as a company sale or listing.

Tax treatment

Where growth shares are acquired by reason of employment, they will normally fall within the employment-related securities rules in Part 7 of ITEPA 2003.

In those circumstances, income tax may arise on the difference between the market value of the shares and any amount paid for them. Because growth shares participate only in future growth, their market value is often lower than that of ordinary shares.

Growth shares frequently contain restrictions, such as limitations on transfer or forfeiture provisions. Where this is the case, the shares will generally be treated as restricted securities under ITEPA 2003, Chapter 2 Part 7.

It is common for a joint election under ITEPA 2003, s.431 to be made so that the tax position is determined at the time the shares are acquired rather than when restrictions later cease to apply.

If the shares are readily convertible assets, any income tax due must normally be accounted for through PAYE, and National Insurance contributions may also arise.

Valuing growth shares

Valuation is a critical element of any growth share arrangement.

The value of the shares at the time they are issued determines the amount on which tax may be charged where the shares are acquired by reason of employment. HMRC therefore expects the valuation to reflect the economic rights attached to the shares.

Growth shares should generally be valued using recognised financial modelling techniques, such as:

option pricing models (for example Black–Scholes)
probability weighted expected return methods (PWERM)

These approaches recognise that growth shares may still have “hope value”, even where they only participate above a future hurdle.

Supporting documentation explaining the valuation methodology and assumptions used should be retained.

Implementing growth shares

Implementing a growth share structure normally involves a number of corporate and administrative steps.

These typically include:

📜 Creating a new share class

The company’s articles of association must be amended to introduce the growth share rights.

🗳 Shareholder approval

Changes to the articles and the issue of the new share class generally require shareholder approval by special resolution.

📑 Issuing the shares

The company must formally allot the shares and update its statutory registers.

🏛 Companies House filings

Relevant documents, including amended articles and the return of allotment, must be filed with Companies House.

Where the shares fall within the employment-related securities regime, the scheme must be registered on HMRC’s ERS service if the shares are issued by reason of employment, and annual ERS returns may be required.

Proper documentation and record-keeping are important to support the structure and valuation adopted.

Conclusion

Growth shares are a flexible way of structuring equity participation so that holders benefit only from future increases in company value.

By separating historic value from future growth, they allow companies to introduce new shareholders while protecting the interests of existing owners. However, careful design is essential. In particular, attention should be given to the level of the hurdle, the rights attaching to the shares, and the valuation methodology used.

When implemented properly, growth shares can provide a practical mechanism for aligning interests with the future success of the business.