Growth share schemes

In today's competitive business environment, companies need innovative ways to attract and retain top talent while managing cash flow and protecting existing shareholders.

Growth shares offer a sophisticated solution that balances these competing needs by creating a distinct share class that only participates in future growth. Unlike ordinary shares, growth shares only carry rights to participate in the company's value above a predetermined threshold (the "hurdle"), which will be set at or above current market value. There are no participation rights below the hurdle, which can be fixed or floating.

Key points

• Growth shares are a distinct class of shares with rights only to future value growth. Current shareholders are not diluted and growth shares may not have voting or dividend rights.

• Companies can selectively determine participation without requiring universal employee inclusion or uniform terms across participants.

• Participants must pay the market value for the shares at the time of issue. This value is typically low due to the growth threshold.

• Requires careful structuring and professional advice to implement correctly.. The process typically takes 8-12 weeks from initial instruction to implementation, depending on complexity and whether HMRC clearance is sought.

• Growth shares are not as tax efficient as other share schemes but offer a solution when traditional HMRC-approved schemes like EMI options are unavailable due to qualification restrictions.

Growth shares or options?

Typically, growth shares seem safer to employees as they avoid the classic options problem, needing cash to exercise when leaving or losing the options entirely. However, growth shares typically have harsh leaver provisions forcing transfer at low value. .

Options are better suited for :-

• broader employee incentive schemes

• earlier stage companies

• situations needing simpler administration

• higher turnover environments

• when clean exits might be needed

• EMI-qualifying companies wanting tax advantages

In reality, the choice often depends on company circumstances because typically growth shares are more complex and expensive for the company to implement than options, which also give the company more control.

Potential drawbacks for employees

• Payment cannot be deferred or waived.

• Limited or no voting rights.

• Restricted dividend rights.

• Transfer restrictions and typically include compulsory transfer provisions.

• Good/bad leaver provision risks

Tax considerations with growth shares

• Market value must be paid for shares - HMRC valuation agreement often recommended.

• Employment-related securities provisions apply -Section 431 elections usually advised.

• Future capital gains tax treatment - growth in value typically subject to CGT.

• Entrepreneurs' Relief considerations - may be available subject to qualifying conditions.

Valuation

Needs to be robust and defensible, recommended to obtain HMRC clearance and document assumptions and approach.

Subscription Agreement

The subscription agreement is the cornerstone document for growth shares implementation. Beyond just listing core terms, it serves as a comprehensive contract that details :-

• number and class of shares being issued - specify the exact share class designation (e.g., "B Growth Shares") and precise number of shares, including their nominal value and any share certificate numbers to be issued.

• purchase price - both the subscription price per share and total consideration, including payment mechanics and deadlines. Often set at nominal value to minimize initial tax implications.

• conditions attached to shares - such as performance targets, time-based vesting schedules, and any hurdle rates that must be met before shares participate in value. These conditions directly impact the shares' market value.

• warranties from the employee - employee must confirm their status as a qualifying employee, acknowledge tax obligations, declare no competing interests, and confirm they've received independent legal advice.

• tax indemnities - comprehensive protection for the company against any tax liabilities arising from the growth shares, including employer's NICs and penalties. Should cover both issuance and future disposals.

Plan/Scheme Rules

These establish the governance framework for the entire growth share scheme and will include :-

• eligibility criteria - minimum employment duration, performance requirements, and any excluded categories of employees. Should align with company's broader remuneration strategy.

• vesting conditions - including cliff periods, acceleration events, and whether vesting is time-based, performance-based, or both. Should define how corporate events affect vesting.

• good/bad leaver provisions - what constitutes each leaver category and resulting consequences for both vested and unvested shares. Include specific examples and valuation mechanics.

• how shares will be valued - methodology for determining fair market value, including timing of valuations, appointment of valuers, and appeal processes. Should cover various transfer scenarios.

• circumstances when shares must be transferred back - such as breaches of warranties, insolvency, and other trigger events. Must detail transfer process and price determination.

Amendments to Shareholders' Agreement

The deed of adherence brings growth shareholders into the existing governance framework:

• transfer restrictions - pre-emption rights, board approval requirements, and permitted transfer exemptions. Should be tailored to protect company's interests while providing reasonable liquidity options.

• drag-along and tag-along rights - detailed mechanics for forcing or allowing participation in company sale, including notice requirements and price determination.

• confidentiality obligations - scope of confidential information, duration of obligations, and permitted disclosures. Should align with employment terms.

• non-compete provisions - geographic and temporal scope of restrictions, definition of competing activities, and enforcement mechanisms.

Changes to Articles of Association

Articles modifications require careful drafting to :-

• create the new class of growth shares - full rights profile including voting, dividends, capital rights, and conversion provisions. Must be precisely defined to achieve intended economic outcome.

• define the rights attached - detail participation thresholds, anti-dilution protection, and any class consent matters. Consider interaction with existing share classes.

• set out any restrictions - transfer restrictions, compulsory transfer provisions, and forfeiture mechanisms must be clearly articulated and enforceable.

Employment contract considerations

The employment relationship generally intersects with growth shares. While the employment contract may reference the growth share scheme, the detailed terms are usually kept separate to maintain flexibility in modifying the scheme and avoid creating contractual entitlements.

The contract might include general provisions about complying with any company share schemes, reinforcing the binding nature of scheme rules and consequences of breach.

Company law formalities

Essential compliance steps include:

• Board and shareholder approval required - Proper authorizations including board minutes, shareholder resolutions, and any necessary investment agreement amendments.

• Companies House filing obligations - Updates to PSC register, SH01 forms for share allotments, articles amendments, and confirmation statements. Strict filing deadlines apply.

How we can help

For companies implementing growth shares, proper documentation and structuring are crucial for both legal compliance and achieving intended commercial outcomes. We guide companies through the entire process, from initial scheme design to implementation. Our services include :-

• Drafting all required documentation.

• Helping to structure tax-efficient arrangements.

• Obtaining HMRC clearances where beneficial.

• Advising on corporate governance requirements.

• Ensuring proper board and shareholder approvals.

We also help employees understand their rights and obligations when offered growth shares. Our support covers :-

• Reviewing subscription agreements and scheme documentation.

• Explaining tax implications and available elections.

• Advising on vesting conditions and leaver provisions.

• Understanding shareholder rights and restrictions.

Whether you're an employer planning to implement a growth share scheme or an employee being offered growth shares, we can help ensure your interests are protected.