Growth Shares for Family Businesses

For many family businesses, succession planning is about much more than deciding who will take over when the current owners retire. A key challenge is often how to transfer value to the next generation in a controlled and tax-efficient manner, whilst preserving stability, protecting family relationships and ensuring the continued success of the business. An increasingly popular way of tackling this challenge is the use of growth shares.

Growth shares are a specialist class of shares which allow the next generation to benefit from the future growth in value of a company whilst also enabling existing shareholders to retain value that has already been created. When structured correctly, growth shares can, amongst other things, form a valuable part of a family’s wider succession and inheritance tax (“IHT”) planning strategy.

A growth share is a share that only participates in the value of a company above a predetermined “hurdle”. The hurdle is usually set by reference to the current value of the business at the time the growth shares are created. However, the value of the hurdle can be altered based on commercial objectives and circumstances.

For example, if a company is valued at £2 million, growth shares might be structured so that the holders of the growth shares only participate on a share sale in the value above that figure. The parents (the original shareholders) would retain entitlement to the first £2 million of value, whilst the growth shareholders (the children) participate in any increase thereafter. This can be particularly common in instances where the original shareholders of a business wish to reward and encourage the next generation but are not yet prepared to transfer the full value of their shareholding.

Growth shares can also provide significant estate planning opportunities. From an IHT perspective, one of the key advantages is that future value growth can potentially be transferred out of the older generation’s estate during their lifetime. If that future growth accrues to shares held by children or other family members, any increase in value should generally belong to those shareholders rather than the older generation. This can be particularly effective where the business is expected to experience substantial growth over the coming years. Rather than allowing all that future value to remain within the original shareholders’ estates, growth shares can enable a proportion of the value to be transferred elsewhere.

Again, it should be highlighted that the level at which the hurdle is set can have a significant impact on the effectiveness of the planning. For example, where succession and IHT planning are key objectives, some families may choose to set the hurdle at a level below the company’s full market value. In practical terms, this means that a greater proportion of the company’s existing value (as well as future growth) is capable of being transferred to the growth shareholders.

As demonstrated, whilst growth shares are often perceived to only cover “future growth”, there is flexibility in how the hurdle is structured. Provided the arrangements are supported by correct valuation advice and implemented correctly, setting a lower hurdle can allow more value to pass to the next generation while the original shareholders are still alive. This has the potential to reduce the value of their estates for IHT purposes and accelerate the transfer of family wealth.

For example, rather than setting the hurdle at a full company valuation of £5 million, advisers may consider whether a lower economic threshold could be justified depending on the rights attached to the various share classes and wider planning objectives. As a result, the hurdle could be set at £4 million, meaning the growth shares may capture a larger element of future value creation and potentially some value that would otherwise remain within the parents’ estates. Despite this, any growth share arrangement must have a genuine commercial rationale and be supported by robust tax and valuation advice. HMRC will expect the valuation of the shares and the rights attached to them to reflect economic reality.

Growth shares can be extremely effective, but they are not a “one-size-fits-all” solution. Consequently, family business owners wishing to implement growth shares will require input from solicitors, accountants and tax advisors collectively to ensure that the structure meets both your commercial and tax objectives.

Growth shares can provide an elegant solution for families seeking to balance succession planning, business continuity and inheritance tax considerations. By enabling the next generation to participate in future value creation whilst allowing founders to retain control and protect existing wealth, they can form a key part of a long-term family business strategy.

The information and opinions contained in this blog are for information only.  They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice.  Before acting on any information contained in this blog, please seek solicitor’s advice from Gilson Gray.