Growth Shares for Inheritance Tax Planning: A Strategic Guide for UK Business Owners

In my practice as a specialist corporate solicitor advising UK businesses, I’ve witnessed how growth shares have revolutionised inheritance tax planning strategies. These sophisticated equity instruments have become indispensable tools for business owners seeking to transfer wealth efficiently whilst maintaining control over their wealth. This comprehensive guide explores how growth shares, particularly when combined with Family Investment Companies, can transform your approach to succession planning and wealth preservation.

What Are Growth Shares and How Do They Capture Future Growth?

Growth shares represent a distinct class of shares designed to participate in the future value appreciation of a company above a predetermined threshold, known as the “hurdle rate” or “base value”. They are often created as a new class or special class of shares with specific rights that distinguish them from other share classes. Unlike standard ordinary shares that carry rights to the company’s entire value from day one, growth shares only capture value created above a pre-determined threshold (the hurdle), making them particularly attractive for inheritance tax planning purposes. It is further possible to combine growth shares with value-capped ordinary shares (usually held by the existing shareholders, the founders of the company, typically the parents in the family), as to enable inheritance tax planning. More on this below.

In essence, a growth share allows new shareholders—typically the next generation in a family, or key employees—to benefit from the company’s future success without immediately inheriting its current worth. Compared to existing ordinary shares, growth shares do not entitle holders to the company’s value up to the current value at the time of issuance, but only to the increase above that threshold. This structure creates a powerful mechanism for transferring future wealth whilst minimising the immediate tax implications. To learn about the different ways to value a business, read this related blog.

If the growth shares are intended for employees, usually the economic hurdle is usually set to the current company valuation or higher. When it comes to incentivising employees, growth shares can be a highly effective tool. Compared to employee shareholder schemes, a growth share plan can offer a more flexible alternative for aligning key employees’ interests with the company’s future growth.

Instead, if using growth shares as part of inheritance tax planning, the hurdle is usually set in line with what the parents have left in tax-free allowance (the nil-rate band) to pass on to their children. For example, if the parents already have assets of £750k outside of the company in question and their total (combined) tax-free allowance (nil-rate band) for IHT purposes is £1m, then they will want the growth shares to capture any value of the company above £250k (as to avoid going above the £1m threshold and, therefore, triggering IHT being payable on the excess).

Benefits of Growth Shares

Growth shares deliver a range of compelling benefits for both companies and their employees, making them an increasingly popular choice for private companies, start-ups, and private equity backed companies with substantial growth prospects. One of the primary advantages is their tax efficient structure: growth shares are typically subject to capital gains tax (CGT) rather than income tax, allowing employees to benefit from a lower tax rate on any increase in the value of the company. This makes growth shares a highly attractive, tax efficient way to incentivise key employees, aligning their interests with the long-term success of the business.

For employers, growth shares offer a strategic tool to attract, motivate, and retain top talent without imposing a significant upfront cost. Unlike ordinary shares, which immediately dilute the ownership of existing shareholders, growth shares only participate in the value of the company above a predetermined hurdle. This means the dilutive impact on existing shareholders is minimised, as only the future growth is shared with new participants. As a result, companies can reward key employees for driving company growth while safeguarding the value already built by current owners.

Additionally, growth shares are particularly well-suited to private companies and investment companies seeking to compete for talent in a competitive market. By offering a share in the future value of the company, businesses can create a powerful incentive for employees to contribute to the company’s ongoing success, all in a tax efficient manner that benefits both the company and its people.

How Do Growth Shares Work?

As mentioned above, growth shares only capture the value of the company above a certain, pre-determined threshold. In practice, that means that if the company were to be liquidated and all of its assets be sold, how much of the proceeds will that specific class of shares receive? We are specifically talking about the right to receive “capital distributions”. Here is an example of how different classes may be structured.

I show below an example of a company where the existing shareholders (usually two parents, holding Ordinary shares) want to cap the value of all of their shares to £250k:

It’s important to note that each company may attach different rights and restrictions to their share classes as they wish. Accordingly, there is no set, fixed way that growth shares must be. To learn more about how to customise your different classes of shares (and the various right and restrictions you can use) read this blog.

Growth shares are typically issued as a separate share class within the company’s share capital. When structuring economic rights, as the company increases in value, the share value of growth shares rises accordingly.

Structuring the Share Rights

As mentioned above, growth shares typically incorporate specific rights and restrictions that distinguish them from ordinary shares. Growth shares are often structured as a separate share class or special class, with tailored rights designed to meet specific objectives such as incentivising employees or facilitating tax planning. These might include:

Economic Rights: Growth shares generally don’t participate in distributions until the hurdle value is exceeded. Once this threshold is crossed, they may receive a percentage of the excess value, often on a pro-rata basis with other shareholders.

Voting Rights: Depending on the family’s objectives, growth shares may carry full, limited, or no voting rights. In Family Investment Companies, I often recommend limited voting rights to maintain founder control whilst engaging the next generation.

Dividend Rights: Growth share structures can include dividend rights. This is another significant advantage of creating different classes of shares, namely the Company (via a decision of the board of directors) can give different dividends to different classes of shares, which is usually advantageous when trying to distribute the company’s profits in a tax-efficient manner (with special consideration for the existing shareholders’ income tax liabilities and thresholds).

Exit Provisions: Clear mechanisms for realising value upon sale, listing, or other exit events ensure growth shareholders can benefit from their investment when liquidity events occur.

Vesting Arrangements

Implementing vesting schedules adds another layer of sophistication to growth share schemes. These arrangements can:

• Encourage long-term commitment from family members or employees.

• Protect the company if shareholders leave prematurely.

• Align interests across different generations and stakeholders.

How Can Growth Shares Be Used for Inheritance Tax Planning?

Growth shares have emerged as one of the most effective tools for inheritance tax mitigation in my corporate law practice. Their unique structure offers multiple advantages for families seeking to preserve wealth across generations whilst maintaining business continuity. Growth shares can also be transferred to other family members as part of a broader succession plan, allowing for the efficient transfer of future company growth while optimising inheritance tax benefits.

Immediate Tax Benefits (capital gains tax, income tax)

When parents or business founders issue growth shares to their children or trusts, the immediate inheritance tax implications can be significant so long as the founders survive (don’t die) for at least 7 years from the day of making the gift. This is because the value of the shares gifted (since they are no longer owned by the founder) no longer form part of the founder’s estate for inheritance tax purposes, but only if the founder doesn’t die within 7 years of the gift.

Further, there is typically no capital gains tax payable by existing shareholders when their company issues growth shares to the children, and usually the recipients would not pay income tax on the receipt of such shares (although may pay income tax or dividend tax on the dividends they receive, or pay capital gains tax if they go on to sell those shares).

Business Property Relief Optimisation by Existing Shareholders

Growth shares in trading companies or Family Investment Companies that qualify as trading entities may be able to benefit from Business Property Relief, potentially reducing inheritance tax to zero on qualifying assets.

To maximise BPR availability:

• Ensure the company maintains trading status if required

• Avoid excessive investment activities that might compromise relief

• Document commercial rationale for all transactions

• Maintain proper records demonstrating business purposes

• Consider the two-year ownership requirement for relief qualification

Income tax may remain payable if the relevant asset is paying an income to the existing shareholder.

Family Investment Company Integration

Growth shares work exceptionally well within Family Investment Companies, creating sophisticated structures that combine investment management with tax-efficient wealth transfer. In these arrangements, founders typically retain control through voting shares whilst issuing growth shares to children or family trusts.

This structure allows families to:

• Maintain founder control over investment decisions

• Transfer excess investment growth to the next generation

• Create flexibility for future succession planning

How to Create Growth Shares for Your Family Investment Company

Establishing growth shares within a Family Investment Company requires careful planning and professional implementation. This process often involves creating a new class of shares within the company’s share capital, specifically designed to capture future growth above a certain hurdle. Based on my experience structuring numerous FICs for UK families, here’s a comprehensive approach to creating effective growth share arrangements.

Growth share schemes typically have flexible qualifying criteria, making them accessible to a wide range of participants compared to other share schemes.

Step 1: Establish the Family Investment Company Structure

Before introducing growth shares, ensure your Family Investment Company has the appropriate foundation:

Constitutional Documents: Draft bespoke articles of association that explicitly provide for multiple share classes with differentiated rights. Standard articles rarely accommodate the sophistication required for effective growth share structures.

Initial Capitalisation: Consider how the company will be funded initially. Options include:

• Cash subscriptions from founders

• Transfer of existing investments (considering capital gains tax implications)

• Loan arrangements providing flexibility for future restructuring

Step 2: Design the Growth Class of Shares

Creating effective growth shares requires careful consideration of various design elements:

Hurdle Setting: This typically involves:

• Obtaining formal valuation reports

• Documenting valuation methodologies

• Considering any recent transactions or comparable evidence

• Building in appropriate safety margins

Rights Specification: Define precisely how growth shares will participate above the hurdle. Consider:

• Percentage participation in excess value

• Priority arrangements vis-à-vis other share classes

• Treatment of interim distributions and dividends

• Conversion or redemption mechanisms

Protective Provisions: Incorporate safeguards such as:

• Drag-along and tag-along rights

• Pre-emption provisions on transfer

• Good and bad leaver provisions if applicable

• Anti-dilution protections

Step 3: Implementation Process and adoption of Company’s Articles

The practical implementation of growth shares requires attention to detail and proper documentation:

Board Resolutions: Pass appropriate board resolutions approving:

• The creation of new share classes

• The proposed allotments

• Any constitutional amendments required

• Valuation reports and supporting documentation

Shareholder Approvals: Obtain necessary shareholder consents, particularly if existing articles require amendment or if pre-emption rights need to be disapplied.

Share Allotments: Complete the formal allotment process:

• Issue share certificates or update registers

• File required Companies House forms (SH01)

• Update the company’s register of members

• Document consideration paid (even if nominal)

Conclusion

Growth shares represent a powerful tool for inheritance tax planning, particularly when integrated with Family Investment Companies. Their ability to transfer future value efficiently whilst maintaining current control makes them invaluable for UK business owners and wealthy families seeking to preserve and transfer wealth across generations.

The key to successful implementation lies in careful planning and professional structuring. As tax legislation and family circumstances evolve, these structures must be regularly reviewed and refined to maintain their effectiveness.

For business owners contemplating succession planning or families establishing investment structures, growth shares offer a sophisticated solution that balances tax efficiency with operational flexibility. However, their complexity demands expert guidance to navigate the technical requirements and maximise their benefits.

If you’re considering growth shares for your Family Investment Company or exploring inheritance tax planning strategies, Zoppi & Co’s specialist corporate lawyers can provide the tailored corporate advice and implementation support essential for success. Contact us now for a free legal advice call.