Growth Shares: Employee Incentive Schemes Series

Article 4 of 4

Introduction

In this concluding article of our employee incentive scheme series, we look at growth shares, another manner by which employers can incentivise key employees by allowing them to share in the company’s success once specific performance targets are met.

Growth Shares

Growth shares (commonly referred to as “flowering shares” or “ratchets”) are a special class of ordinary shares that generally have a low or nil value with very limited rights until a certain target or “hurdle” is reached by the business. Due to the low initial value when issued, the growth shares are affordable and upfront tax (if any) is minimal. When the hurdle is achieved, the value and agreed value of the shares flower, and the employee will become entitled to a return.

The hurdle is specified by the employer when the shares are issued, and it may refer, but is not limited, to:

• company performance or valuation;

• a fixed return thresholding for existing shareholders; or

• the key employee’s performance

Simple Example – Company Valuation Hurdle

Assume a company is worth €5 million.

An employee is awarded growth shares with a €5 million valuation hurdle. The shares only participate in any value created above that level.

At grant, the company is worth €5 million, therefore, the shares have no immediate economic value and therefore, no CGT applies when the growth shares are awarded.

Two years later, the company is sold for €8 million. The growth above the hurdle is €3 million.

If the growth shares entitle the employee to 10% of that growth, they receive: 10% × €3 million = €300,000.

Conversely, If the company is sold for less than the €5 million hurdle, the growth shares deliver no value, and the employee is not entitled to any proceeds.

In essence, growth shares only deliver value once the company exceeds the agreed hurdle, allowing employees to share in the upside they help create while preserving the founders’ existing value.

Again, growth shares are usually subject to good and bad leaver provisions, and other restrictions such as vesting schedules and transfer restrictions.

Key features:

• Employees acquire the growth shares in the company as soon as the scheme is launched, typically free of charge or at a discounted value. As a result, the employee becomes a shareholder from the outset, rather than an option holder.

• The issue of growth shares does not dilute the existing shareholding in the company.

• The employee will only benefit where the relevant performance or value hurdle is achieved. If the hurdle is not met, the growth shares may have little or no value.

• On a sale of the company or other disposal of the shares, the holder participates in the value created above the hurdle.

• A disposal of growth shares may give rise to a charge to capital gains tax (CGT). It should be noted that any disposal must be reported to Revenue, even where no tax is payable.

Conclusion

Growth shares represent an excellent option for companies looking to motivate employees while preserving the value of existing shareholders. We hope this series has provided valuable insights into the diverse range of employee incentive schemes available to businesses in Ireland.

If you are considering implementing such a scheme or need legal guidance on structuring one, please don’t hesitate to reach out to Chelsey Heaney or any member of the Power Law team for expert support.