So you’re wondering how to share equity between employees or directors. In the UK, companies have several options available to achieve this. Two of the most common approaches are growth shares and non tax advantaged shares.
As specialist tax advisors, we’ll walk you through what these options are, the reasons you might want to opt for one over the other depending on your aims and the all-important tax implications.
What are non tax advantaged shares?
Our first type of company shares are non tax advantage shares or what’s known as ‘ordinary shares’. They are most likely what the majority of people think of when they imagine company shares – a very literal share of the current value and any future growth to the person who holds them.
What are growth shares?
The second share type is growth shares. These are a special class of shares that only benefit from increases in company value above a predetermined threshold known as the ‘hurdle’. They’re designed to reward employees for helping to grow the business whilst protecting existing shareholders’ current value.
How do growth shares work?
Let’s use an example to explain this simply. Take a company valued at £5 million. The company then creates a new class of shares with rights that only activate when the company value exceeds £6 million (this amount is the hurdle). These shares might entitle the holder to 10% of any value above this hurdle.
If the company later sells for £10 million, the Growth Share holders would receive 10% of the £4 million above the hurdle (£400,000). However, if the company value never exceeds £6 million, these shares would be worth nothing.
What are the key differences between growth shares and non tax advantage shares?
1. The tax treatment
Growth shares:
- Low initial tax charge due to minimal starting value
- Capital Gains Tax (currently 20%) applies to future growth
- Potential for Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) reducing tax to 10%
Non tax advantaged shares:
- Income Tax and National Insurance (up to 47%) on the full value when exercising options
- Higher immediate tax burden for employees
- No special tax treatment
When it comes to taxation, growth shares offer a much more tax-efficient way for employees to benefit from company growth, with potential tax rates less than half of what they would pay on non tax advantaged shares.
2. Value protection
Growth shares:
- Protect existing shareholders’ current value
- Only dilute future growth
- Clear alignment with company success
Non tax advantaged Shares:
- Immediately dilute existing shareholding
- Impact current and future value
- May require significant employee investment
This means that while both types of shares transfer value to new shareholders, growth shares preserve the company’s existing value for current shareholders while non tax advantaged shares immediately transfer a portion of both current and future value.
These differences make growth shares particularly attractive for high-growth companies looking to incentivise key employees while protecting existing shareholder value.
How does this work in practice?
Let’s imagine that you’ve given an employee £10,000 worth of shares using each kind of share type. We’ll show you how the tax and proceeds work out in each scenario.
Growth shares:
- Initial company value: £6 million
- Employee receives shares worth £10,000
- Initial tax charge: £4,700
- If company sells for £10 million: CGT of £76,800
- Total tax: £81,500
- Net proceeds: £318,500
Non tax advantaged options:
- Initial company value: £6 million
- Employee receives shares worth £10,000
- No initial tax
- Tax at exercise: £188,000
- Total tax: £188,000
- Net proceeds: £212,000
Which option is best?
While both share types have their place, they tend to work best in different scenarios:
Growth shares are typically the better choice for:
- Companies that expect significant growth in the future and want to reward employees for helping achieve it
- Private businesses looking to protect existing shareholder value while incentivising key staff
- Situations where minimising the employee’s initial tax burden is important
- Businesses that want to create a clear link between company performance and employee rewards
Non tax advantaged shares might be more suitable when:
- The company wants to keep its share structure straightforward and simple
- There’s a desire to give employees immediate participation in the current value of the business
- The company’s growth potential is expected to be more modest
- Administrative simplicity is a priority over tax efficiency
The final choice often depends on your specific circumstances, so it’s worth consulting with advisors to determine the best approach for your situation.
Discuss the best share options for you with a specialist
Every company has unique needs when it comes to share schemes – from growth expectations and existing shareholdings to tax considerations. Our expert team of accountants can help you weigh the many variables with your circumstances and goals in mind. That way we can design a share scheme that meets all of your needs as efficiently as possible.
Get in touch today to discuss your options.