What are growth shares and how do they work?

Growth shares are a class of shares that only have economic value if the company's value exceeds a specified hurdle. Employees acquire the shares at a low market value and benefit only from future growth above the hurdle, protecting existing shareholders. Growth shares are a separate class of shares that only participate in the growth of the company above a specified hurdle. How they work: (1) Hurdle — a hurdle is set at the current market value of the company (agreed with HMRC for EMI/CSOP, or determined by a professional valuation). For example, if the company is currently valued at £10 million, the hurdle might be set at £10 million. (2) Share class — a new class of shares is created (growth shares) that only have economic value if the company is sold for more than the hurdle. (3) Acquisition — employees acquire the growth shares, typically at a low market value (as the shares only have value above the hurdle, their current market value is low). (4) Disposal — if the company is sold for more than the hurdle, the growth shares participate in the upside. If the company is sold for less than the hurdle, the growth shares are worthless. (5) Protection — the hurdle protects existing shareholders from dilution of existing value. Employees only benefit from value they help create. Growth shares are commonly used in private companies and can be combined with EMI or CSOP options for additional tax efficiency. Relevant legislation: Companies Act 2006 (share class creation); ITEPA 2003, Part 7 (employment-related securities); TCGA 1992, Section 169I (BADR for EMI/CSOP growth shares). Example: A company is valued at £10 million. It creates growth shares with a hurdle of £10 million. An employee acquires 10,000 growth shares at £0.10 per share (market value at acquisition = £1,000). If the company is sold for £15 million, the growth shares participate in the £5 million growth above the hurdle. If the company is sold for £8 million (below the hurdle), the growth shares are worthless. Common mistake: Setting the hurdle too low. If the hurdle is below the current market value, the growth shares have immediate value, and the employee may face income tax on acquisition. The hurdle should be set at or above the current market value.

How are growth shares taxed?

If the employee purchases growth shares at market value, there is no income tax. On disposal, the gain is subject to CGT. If acquired through EMI or CSOP options, 10% BADR applies. If acquired through unapproved options, income tax is due on exercise. The tax treatment of growth shares depends on how they are acquired: (1) Direct purchase — if the employee purchases the growth shares at their market value (which is typically low, as the shares only have value above the hurdle), there is no income tax or NIC on acquisition. The market value must be determined by a professional valuation and agreed with HMRC (for EMI/CSOP). On disposal, the gain (sale proceeds minus purchase price) is subject to CGT at 24% (higher rate) or 10% if BADR applies. (2) EMI options — if the growth shares are acquired through EMI options, the EMI tax advantages apply: no income tax on exercise (if exercise price ≥ market value at grant), and 18% BADR on disposal. This is the most tax-efficient structure. (3) CSOP options — from April 2023, CSOP options can be granted over growth shares, providing the same tax advantages as EMI (no income tax on exercise, 10% BADR). (4) Unapproved options — if acquired through unapproved (non-tax-advantaged) options, income tax at up to 45% is due on the gain at exercise (market value at exercise minus exercise price). On disposal, CGT at 24% applies (no automatic BADR). The most tax-efficient structure is EMI or CSOP options over growth shares, providing no income tax on exercise and 18% BADR on disposal. Relevant legislation: ITEPA 2003, Part 7 (employment-related securities); Schedule 5 ITEPA 2003 (EMI); Schedule 4 ITEPA 2003 (CSOP); TCGA 1992, Section 169I (BADR). Example: An employee acquires 10,000 growth shares at £0.10 per share (market value = £1,000) through EMI options (exercise price = £1,000). On exercise, no income tax (exercise price = market value at grant). The company is sold for £15 million, and the growth shares are worth £50,000. The employee sells the shares for £50,000. The gain is £49,000 (£50,000 - £1,000). CGT at 18% BADR = £4,900. Total tax: £4,900. Common mistake: Not obtaining HMRC valuation agreement for the growth shares before acquisition. The market value of growth shares can be difficult to determine, and without HMRC agreement, the valuation may be challenged, potentially resulting in income tax charges.

How is the hurdle for growth shares determined?

The hurdle is typically set at the current market value of the company, determined by a professional valuation and agreed with HMRC (for EMI/CSOP). The hurdle ensures the growth shares only participate in future growth. The hurdle is a crucial element of growth shares. It determines the threshold above which the growth shares have economic value. How the hurdle is determined: (1) Professional valuation — a professional valuation of the company is obtained, typically from a corporate finance adviser or valuer. The valuation considers the company's financial performance, assets, market position, and comparable transactions. (2) HMRC agreement — if the growth shares are to be acquired through EMI or CSOP options, the market value (and hence the hurdle) must be agreed with HMRC. HMRC offers an Advance Assurance service for EMI valuations, providing certainty before the options are granted. (3) Hurdle level — the hurdle is typically set at the current market value of the company. This ensures that the growth shares only participate in future growth (not existing value). (4) Hurdle structure — the hurdle can be structured in various ways: a fixed amount per share, a percentage of the total proceeds, or a formula based on financial metrics. The structure should be commercially appropriate and legally documented. (5) Review — the hurdle may need to be reviewed if the company's circumstances change significantly (e.g., a new funding round). Setting the right hurdle is essential — too low and the growth shares have immediate value (triggering income tax), too high and the shares may never have value (demotivating employees). Relevant legislation: Companies Act 2006 (share class and rights); ITEPA 2003, Part 7 (market valuation for employment-related securities). Example: A company is professionally valued at £10 million. The hurdle for growth shares is set at £10 million. The growth shares only have value if the company is sold for more than £10 million. If the company is sold for £15 million, the growth shares participate in the £5 million growth above the hurdle. HMRC agrees the valuation for EMI/CSOP purposes through the Advance Assurance process. Common mistake: Setting the hurdle without a professional valuation and HMRC agreement. If the hurdle is set too low (below the true market value), the growth shares have immediate value, and the employee may face income tax on acquisition.

Should I use growth shares or EMI options?

It depends on your company's circumstances. EMI options are simpler and more tax-efficient but have eligibility restrictions. Growth shares offer more flexibility (no work commitment, no qualifying company requirements) but require a professional valuation and legal structuring. The choice between growth shares and EMI options depends on several factors: (1) Company eligibility — EMI is only available to qualifying companies (unlisted, gross assets up to £30 million, fewer than 250 employees, qualifying trade). Growth shares can be issued by any company, regardless of size, listing status, or trade. (2) Work commitment — EMI requires the employee to work 25 hours/week or 75% of working time. Growth shares have no work commitment requirement — they can be issued to any employee, advisor, or consultant. (3) Tax efficiency — EMI options over growth shares provide the best of both worlds: no income tax on exercise and 18% BADR on disposal. Growth shares acquired directly (without EMI) are subject to CGT at 24% (or 10% if BADR conditions are met separately). (4) Complexity — EMI is simpler to set up (standard option documentation, HMRC Advance Assurance). Growth shares require a professional valuation, creation of a new share class, and legal documentation (articles of association, shareholders' agreement). (5) Dilution — growth shares protect existing shareholders from dilution of existing value (through the hurdle). EMI options over existing shares do not provide this protection. (6) Flexibility — growth shares can be customised (different hurdles, different participation rates, different voting rights). EMI options are more standardised. For qualifying companies, EMI options over growth shares is often the preferred structure. For non-qualifying companies, growth shares (possibly through CSOP) is the alternative. Relevant legislation: Schedule 5 ITEPA 2003 (EMI); Companies Act 2006 (growth shares); Schedule 4 ITEPA 2003 (CSOP over growth shares from April 2023). Example: A qualifying technology company wants to reward employees for future growth. EMI options over growth shares is the preferred structure: EMI provides the tax advantages (no income tax on exercise, 10% BADR), and the growth share hurdle protects existing shareholders from dilution of existing value. A non-qualifying company (e.g., a listed company) can use CSOP options over growth shares for similar benefits. Common mistake: Using growth shares without EMI/CSOP when the company qualifies for EMI/CSOP. The combination of EMI/CSOP and growth shares provides superior tax efficiency compared to growth shares alone.

Can growth shares qualify for BADR?

Yes. Growth shares acquired through EMI or CSOP options automatically qualify for 18% BADR on disposal. Growth shares acquired directly may also qualify for BADR if the conditions are met (5% shareholding and officer role for 24 months). Business Asset Disposal Relief (BADR) reduces the CGT rate to 10% on qualifying disposals. Growth shares can qualify for BADR in two ways: (1) EMI/CSOP acquisition — if the growth shares are acquired through EMI or CSOP options, they automatically qualify for 18% BADR on disposal (without needing to meet the 5% shareholding and officer conditions). The 2-year holding period starts from the date of exercise of the EMI/CSOP option (or the date of grant of the EMI option, if earlier). This is the simplest way to obtain BADR for growth shares. (2) Direct acquisition — if the growth shares are acquired directly (by purchase), they may qualify for BADR if the general conditions are met: (a) the employee holds at least 5% of the ordinary share capital and 5% of the voting rights, and is also entitled to at least 5% of the profits available for distribution and 5% of the assets on winding up; (b) the employee is an officer or employee of the company; (c) these conditions are met for at least 24 months before the disposal. The 5% shareholding and officer conditions can be difficult to meet for employees with small growth share holdings, which is why EMI/CSOP acquisition is generally preferred. The BADR lifetime limit is £1 million per individual. Relevant legislation: TCGA 1992, Section 169I (BADR for EMI/CSOP shares); TCGA 1992, Sections 169A-169K (general BADR conditions). Example: An employee acquires growth shares through EMI options. The growth shares represent less than 5% of the share capital. Despite the small holding, the shares qualify for 10% BADR (because they were acquired through EMI). If the employee had acquired the same growth shares directly (without EMI), the 5% shareholding condition would not be met, and BADR would not be available (CGT at 24% would apply instead). Common mistake: Assuming that growth shares acquired directly automatically qualify for BADR. The 5% shareholding and officer conditions must be met, which is often not the case for employees with small growth share holdings.

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Growth Shares Explained

Growth shares reward employees for future growth in company value, with a hurdle that protects existing shareholders. Understand how they work and their tax treatment.

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Growth shares are a popular alternative to EMI options for rewarding employees. They are a class of shares that only participate in the growth of the company above a certain hurdle (e.g., the current valuation). This means employees only benefit if the company grows beyond its current value, protecting existing shareholders from dilution of existing value. Growth shares can be highly tax-efficient, especially when combined with EMI or CSOP options.

How Growth Shares Work

Growth shares are a separate class of shares that only have economic value if the company's value exceeds a specified hurdle. The hurdle is typically set at the current market value of the company (agreed with HMRC). If the company is sold for more than the hurdle, the growth shares participate in the upside. If the company is sold for less than the hurdle, the growth shares are worthless. This structure ensures that employees are rewarded only for future growth, not for the existing value of the company.

Tax Treatment

When an employee acquires growth shares, the tax treatment depends on how they are acquired: (1) Purchase — if the employee purchases the shares at market value (which is typically low, as the shares only have value above the hurdle), there is no income tax or NIC. (2) EMI/CSOP options — if the growth shares are acquired through EMI or CSOP options, the tax advantages of those schemes apply (no income tax on exercise, 18% BADR on disposal). (3) Unapproved options — if acquired through unapproved options, income tax is due on the gain at exercise. (4) Disposal — when the shares are sold, the gain is subject to CGT. If the shares were acquired through EMI or CSOP, BADR at 10% applies.

The Hurdle

The hurdle is a crucial element of growth shares. It is typically set at the current market value of the company, as agreed with HMRC (for EMI/CSOP) or determined by a professional valuation. The hurdle ensures that the growth shares only participate in value created after the hurdle is set. This protects existing shareholders from dilution of existing value and ensures that employees are incentivised to grow the business. The hurdle can be structured in various ways (e.g., a fixed amount per share, or a percentage of the total proceeds).

Advantages and Disadvantages

Advantages of growth shares: (1) No dilution of existing value — existing shareholders' value is protected by the hurdle. (2) Tax-efficient — can be combined with EMI or CSOP for 10% BADR. (3) Flexibility — the hurdle and share terms can be customised. (4) No work commitment — unlike EMI, growth shares can be issued to any employee or advisor. Disadvantages: (1) Valuation — the hurdle requires a professional valuation and HMRC agreement. (2) Complexity — setting up growth shares requires legal and tax advice. (3) No tax advantages if not combined with EMI/CSOP — unapproved growth shares are subject to full income tax and CGT.

Key Points

What You Need to Know

Growth shares only participate in value above a specified hurdle
The hurdle protects existing shareholders from dilution of existing value
Can be combined with EMI or CSOP for 18% BADR on disposal
The market value at acquisition is typically low (making the shares affordable)
No work commitment requirement (unlike EMI)

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EMI Eligibility & Qualifying Companies EMI Tax Advantages Company Share Option Plan (CSOP)Growth Shares Business Asset Disposal Relief (BADR)Share Schemes on Exit Save As You Earn (SAYE / Sharesave)Unapproved Options & RSUs Share Incentive Plan (SIP)Employee Ownership Trusts (EOTs)Share Valuation for EMI & CSOP HMRC EMI Notification & Reporting Phantom Shares & Cash-Settled Awards Share Schemes on IPO

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