For private companies, a common share incentive route often involves growth shares. This is a well-trodden path and rightly so. Growth shares can deliver mutual advantages to both the company and the employee.
What are growth shares?
When the employer wants to give employees an interest in the company, growth shares are often used. Growth shares refer to an interest in a company; which shares only in the upside growth and value of a business. Meaning, that employees issued with growth shares, only share in the ‘increase in value’ of the business.
Usually, they are issued to employees in businesses which are expected to experience above-average growth in revenue, earnings and overall value. On this basis the employee’s expectation is that whilst they will not share in the day one value, there are good prospects for future growth.
Companies focused on growth may find growth shares attractive
Companies that grant growth shares may be in the early stages of expansion or have a strong track record of growth. Employees will typically purchase, or be given, growth shares with the expectation of receiving high returns.
Growth shares are tax efficient for employees
Given that the growth shares only provide a share in the ‘increase in capital value’, they are usually tax efficient to grant because their day one value is small. This makes it easier for the employees to purchase the shares. Growth shares may be more attractive than trying to provide employees with ‘actual value’ on day one because the latter may lead to an inefficient tax charge on issue, or require the employee to purchase the shares at an unattractive or unachievable value.
Growth shares require a signed shareholders agreement
Growth shares will usually result in a higher cost of implementation than share options (Share options are the promise of ownership of shares in the company; at a fixed point in the future; at a fixed price). This is because the employees will hold actual shares, which makes them shareholders. Even if they are non-voting shareholders, the other shareholders should still require the employee to sign a shareholders’ agreement. This is to ensure:
- That the employee’s holding of the shares is regulated
- That it will not stop the other shareholders continuing with their plans for the future of the company, eg the timing of the sale of the company.
- An exit process is specified, should it be required.
If the growth shareholder leaves, given that it is not a share option, which would usually simply lapse, the shareholders’ agreement will need to specify what happens to the shares of the departing employee. This may include whether they are required to transfer the shares back to the other shareholders, and at what value.
Growth shares; a good alternative to share options
Growth shares are seen as a good alternative to share options. Giving employees an actual share in the company, and in that sense ‘skin in the game’ could be preferable to simply a share option, where they may not feel part of the overall ownership.