“What are growth shares?” is usually what people say when I suggest that they might want to think about growth shares. Or “how do growth shares work?”
As I quite often recommend to people that they might want to think about growth shares when they come to talk to me about giving shares to key employees, here’s an article to get you started on understanding the big “what are growth shares” question.
If you’re just at the beginning of thinking about all this shares stuff, you might want to start with this article about giving shares in your business to other people.
What are growth shares?
Growth shares are a way of giving someone else shares in your company, but they only get the benefits of the shares in the part of the company which grows after they get the shares. Hence the term growth shares.
It’s easiest to show how growth shares work with a little story based on someone I suggested growth shares to. Obviously, I’ve changed some of the details here to keep their identity secret.
How do growth shares work in practice?
My client, let’s call her Esmeralda, had spent the last 10 years building up a consultancy practice. The company was now turning over 2.3m, and she had 20 employees.
Esmeralda was now 51 (a great age btw) and wanted to slow down a bit after working ridiculously hard for the past 10 years. She was also looking ahead and thinking that she might want to retire in 10 years’ time, and sell the company.
She’s offered a senior job to someone who was currently working for a competitor. Let’s call him Alex. Alex was really good, and quite a bit younger than Esmeralda. She knew that he was currently earning 85k a year.
Esmeralda wanted Alex to come and work at her company, but she didn’t want to pay 85k. Partly because it’s a lot of money, but mostly because the other senior people who worked for her were only getting 50k, and she didn’t want to give everyone pay rises.
Esmeralda had already thought things through and was considering giving Alex some shares as a way of encouraging him to come and work at her company. She wasn’t sure about the best way to do this, so she booked a couple of hours with me to talk it over.
She wanted to give some shares to Alex, and at the same time give some shares to four other senior staff. But she was aware that if she just gave them shares in her company, they’d have to pay tax on the shares because her company was already worth serious money. That didn’t seem very fair, giving them a massive tax bill. And she owned up in our meeting to resenting giving them shares in the company she’d worked so hard to build up, and taken all the risks on.
Why I suggested growth shares to Esmeralda
This is where I suggested that Esmeralda thought about growth shares. This is how I put it to her.
“Your company has profits of about 120k. So, it’s probably worth at least half a million if you sold it today. When Alex comes in and works hard, along with the other folk, you could probably be worth four or five times that in 10 years.
If you give the others growth shares now and then sell the company in 10 years, you get to keep all of that half a million, plus most of the rest of the growth. The others could each have 5% of the growth shares. Then if you sold for 3m, they’d get 100k each, and you’d get the half million it’s worth now, plus 75% of the growth, or 2.3m in total. Which would be a great bonus for them, plus a good retirement fund for you.”
Why would you want to use growth shares?
I think you get the idea now. Growth shares are a great way of giving shares to a key employee, but keeping the existing value of the company for yourself. The employee has a great incentive to help grow the company because they get a share of the increase in value when it’s sold.
Growth shares also allow you to give dividends to these staff as a lovely top up to their salary. Or in Alex’s case to compensate for a lower salary than he was getting before. Even though these dividends might be quite small, it still keeps staff thinking about how they can increase profit levels, because they’ll get a share of those profit levels now and when the company is sold.
Growth shares are also really useful if, like Esmeralda, you’re thinking about your exit. She wasn’t sure if she wanted to sell her company to one of her competitors or a bigger company (a trade sale) or if she’d like to sell the company to some of the staff (a management buyout).
She didn’t need to decide that right now, but giving the growth shares to the senior managers meant that she would have started that process of transferring some of the ownership to other people in the company while keeping her options open.
Advantages of growth shares
Growth shares are great when your business has been going for a while and has some profits because it avoids HMRC sending a massive bill to your employees because you were nice enough to give them some shares.
Growth shares are also good for a company which already has some decent profits because you get to keep what you’ve already created while rewarding and incentivising staff to make the company grow bigger still.
People often compare growth shares with the EMI share option scheme which has different tax advantages for staff. Growth shares are often a better option than the EMI share option scheme because you can also give staff a dividend.
I think this is good because it gets them starting to think like co-owners of the company, and they get a boost when it’s doing well. You can make the dividend optional, to protect yourself so you get the first set of dividends, which can be important if you have a year when the profit isn’t so high or when you want to take out more of the money yourself to pay for your new kitchen.
Where growth shares are not such a good idea
Growth shares are not needed unless your company has a real value already. If you’re just starting up, you don’t need growth shares. Or if you’ve been recycling most of the profit back into growing the company, and there’s not much left on the profit and loss account, growth shares aren’t such a good idea.
You probably wouldn’t give growth shares if you were giving shares to your wife, husband or partner unless you happen to be married to one of the key staff you want to incentivise.
Other ways of using shares as an employee incentive
Growth shares are one way of getting employees to think long term, stay working for you and to share in the value you’re creating. But they’re not the only way. You should also think about:
- Just giving B class shares to an employee and protecting yourself with a shareholders agreement. This is a simpler way to do it and works well for smaller businesses which don’t have big valuations, or where you want to avoid big legal bills
- Setting up a profit-sharing scheme for key staff or even all the staff. This is much simpler and doesn’t involve letting go of any equity. I’ve advised quite a few companies not to get into all the complexity of issuing shares, and just to set up a profit sharing scheme instead.
- The EMI share options scheme is worth thinking about as well, but works in a completely different way, and is only worthwhile for companies with serious large-scale growth ambitions.
Would you like some help with this?
I really enjoy talking about these issues over with people and helping them to work out a plan of action. Giving away a chunk of your business is the kind of thing you only do once or twice in your life, and it’s really important that you understand exactly how to do this properly, for you and for the people you’re giving shares to.
You can book a two-hour strategy session with me, to talk about the best way to give shares in your company to someone else. We’ll cover things like:
- The best mechanism for doing this, whether that’s using growth shares or a different way
- Work out how many shares you should give to someone
- How to protect yourself and the business.
- We can also work on your negotiation tactics, so you know exactly how to move forward.
Here’s how to book a two-hour session to talk all of this through, and save yourself a fortune in legal fees.
Other helpful articles about how to give shares to others
You might want to also read these articles about shares and equity:
How to give away shares in your business (main article, so start here)
Photo credits to rawpixel and Aaron Huber on Unsplash; Liz Finlayson from Vervate