Growth Shares Blog1

By LyndsayMacGregor, Associate Director, Tax Valuations, Deloitte, UK

Over the past 15 or so years, we have seen many hundreds of companies implement equity incentives using ‘Growth Shares’. 

Growth Shares are a bespoke solution, such that no two arrangements are the same. However, in general terms, they are a separate class of shares, which only deliver a return at a point in the future (generally on exit) and only to the extent that the value of the underlying company at that time exceeds a pre-determined threshold. 

HMRC’s approach to the valuation of Growth Shares has evolved in recent times. Historically, if it could be demonstrated that the shares were ‘out of the money’ at the date of valuation, HMRC were willing to accept that they had little value at acquisition.

In July 2013, a change to HMRC’s Shares and Assets Valuation Manual in respect of the information standards and how they are deemed to apply to the valuation of ‘Growth Shares’, precipitated a change in valuation methodology by some Shares & Asset Valuation officers.  Since then, we have seen a gradual shift away from a liquidation based approach to a forward-looking analysis.  Now, it is HMRC’s view that all Growth Shares should be valued using a forward-looking analysis. 

There are, broadly, two types of forward-looking approach which we see in practice:

  • Expected returns model (ERM)
  • Option pricing

Under an ERM, the value of a Growth Share is estimated based upon an analysis of future values for the subject company assuming a number of future outcomes.  The Growth Share value is based upon the present value of expected future proceeds, reflecting each of the identified possible future outcomes available to the entity and the rights of the security in question.  The key advantage of the ERM is that it is conceptually intuitive and we know it to, currently, be HMRC’s preferred methodology for this type of security.

On the other hand, in some respects the award of Growth Shares may be considered akin to the grant of a share option, where the holder of the option can benefit from increases in the value of a company with a limitation on the downside risk (the relatively small level of required investment).  This is an approach that is often used for accounting purposes but has a number of limitations and will often overvalue the Growth Shares, meaning that adjustments are required.

A similar valuation methodology is advocated by HMRC in relation to other forms of ‘forward-looking’ interest, such as underwater interests in debt and carried interest, and may be adopted in valuing certain ‘sweet equity’ interests.

Around the same time as this changed approach was formalised, HMRC withdrew the discretionary post transaction valuation check (PTVC) service for income tax purposes. This means that it is no longer possible for taxpayers to obtain contemporaneous valuation agreements.

At the current time, it is difficult to know whether the withdrawal of the income tax PTVC will result in an increase in self-assessment enquiries, as the enquiry window for the first year in which PTVCs were not available (2016/17) has not yet opened. However, we do know that agreements reached under the PTVC service were often relied upon during due diligence.

In the absence of an HMRC agreement on historical valuations, it is therefore more important than ever that an organisation's valuation position is underpinned by a robust valuation analysis, based on the most up to date intelligence.

LMacgregor

Lyndsay MacGregor - Associate Director, Tax Valuations, Deloitte 

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