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April 24, 2019

The Future is Bright - Valuation of Growth Shares

The provision of company shares can be a valuable tool in incentivising key members of staff to remain with the company long term and actively grow the company’s business and increase profits.

HMRC has several approved employee share schemes, each with their own tax advantages for the employee and employer/shareholders. However, certain conditions must be met by the employer/employee in order for these schemes to qualify and therefore they are not always commercially viable.

Growth shares are a practical option, especially where the company shares already have significant intrinsic value.

What are Growth Shares?

Suppose that a company wishes to incentivise one of its managers to stay with the business and continue to contribute to the company’s growth and increased profits. At present, the company has 1,000 ordinary shares in issue, with an estimated value of £500 per share i.e. value of the company is £500,000.

If the manager were to acquire say 100 shares, they would either need to pay the current £50,000 market value for them (£500 x 100 shares), or there would be an income tax charge on the value of the shares that they have received (and possibly NIC charges as well).

Alternatively, a new class of growth share could be created that only has rights to proceeds upon sale, and only after the ordinary shares have each received £500 per share. The manager could then subscribe for say 100 growth shares for nominal value, and these shares would be forfeit if the employee left the company for any reason.

Therefore, the manager would only be entitled to receive proceeds upon a sale of the company in excess of £500,000. The first £500,000 would be due to the holders of the ordinary shares.

The value of the shares received by the employee should be relatively small/negligible, considering that if the company were sold for market value the next day i.e. £500 per share, the employee would not receive any proceeds. Any income tax charge will be based upon the value of the shares at acquisition, and so the tax charge will be equally negligible.

HMRC and Valuing Growth Shares

The advantage of growth shares is that any tax implications for the employee when they acquire them should be relatively minimal as the realisable value at the date they are received should effectively be nothing.

However, HMRC guidance provides that it considers forecasts to be relevant when determining the value of growth shares because “the growth prospects are intrinsic to the investment, and no sale would proceed without access to additional information such as company forecasts”. HMRC share valuation manual also cites comments from the Judge in the First Tier Tribunal case Netley v HMRC (UKFTT 0442), who said “No-one would purchase such [growth] shares without having information about future growth prospects.”

Therefore, the potential future value of shares (based on say the expected performance of the company going forward) is considered to affect the current value of shares, and therefore needs to be accounted for. The consideration of forecasts in an initial valuation of growth shares may yield a higher valuation, and therefore any associated income tax charge for employees acquiring such shares.

However, when valuing shares, a number of valuation methods should be taken into account, and all relevant factors should be considered on a case by case basis.

If you require advice on share schemes or share valuations in your situation, please contact us.

Related Articles

A Slice of the Action: Company Share Schemes (Part 1) (17 May 2018)

State Aid Approval for EMI Options Renewed (17 May 2018)

State Aid Approval for EMI Options Lapses (10 April 2018)

Employee Shareholder Status – Practical Benefits (15 May 2015)

Contact us today to discuss your tax requirements.
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