Valuing growth shares can be a complex exercise, particularly for those who don’t deal with them frequently. Without prescriptive guidance from HMRC, many are left wondering: “Why do I need to obtain a valuation of shares that are not worth anything?”
Here are the approaches which have emerged in the market, the reasoning behind these approaches emerging, and the steps a risk-averse taxpayer might take when determining the market value of growth shares.
Evolution of growth share valuation
Historically, HMRC offered a post-transaction valuation checking service for unapproved share schemes. This provided some assurance to companies that the valuation used for issuing shares would not be disputed later.
However, this service was withdrawn in 2016 as part of HMRC’s efforts to streamline processes and place more responsibility on businesses for accurate self-assessment.
Today, HMRC continues to offer a checking service for certain schemes such as EMI and CSOP. But where equity is offered to employees outside of these approved schemes, guidance is limited – particularly on how to support the ‘up front’ value of shares, where a current intrinsic valuation of the underlying business may not capture the true economic substance of the growth shares.
Worked Example Group
Following the withdrawal of the checking service, HMRC convened a Worked Example Group (WEG) which included representatives from HMRC’s Shares and Assets Valuation (SAV) team, professional bodies, and practitioners. The WEG does not represent an HMRC proposal but is intended to promote debate and discussion.
The WEG developed a series of worked examples and illustrative scenarios designed to guide practitioners in valuing shares for UK tax purposes.
One of these worked examples relates specifically to growth shares. Whilst it offers no specific guidance, it recognises that traditional current valuations may fail to capture the potential upside of growth shares and suggests alternative methodologies.
Alternative methodologies proposed include:
- The Probability Weighted Expected Returns Methodology (PWERM)
- Option Pricing Model (OPM) approaches including Black Scholes, Monte Carlo and Binomial models
- Discounted cash flows (DCF) analysis
Current market practice
Whilst the WEG examples do not provide taxpayers with any definitive guidance, HMRC has made two positions clear in recent SAV forums:
- Where shares are issued to employees or directors as a ‘substantial’ part of their remuneration package, HMRC would be uncomfortable if a nil or nominal market value was proposed for these shares
- In an orderly transaction, an informed investor looking to acquire growth shares would demand access to any available forecasts as a condition of investing.
Naturally, the extent to which such shares are considered to form a ‘substantial’ part of an individual’s remuneration package is a subjective question in itself. After all, remuneration packages aren't typically offered a £X with equity or £Y without equity basis.
However, a taxpayer might ask:
“Would a new hire accept this remuneration package without equity reward?”
“Would a current employee remain motivated if equity reward were removed?”
If the answer to either is anything but a resounding ‘yes’, a risk-averse taxpayer would seek to defend their position in relation to the market value of the shares in question.
This typically means going beyond the standard valuation approach for minority shareholdings, using detailed forecast information and potentially applying one or more of the methodologies above.
Given the level of subjectivity and judgement required, engaging a valuation expert is often essential.
For further guidance on growth share valuations or support with a specific scenario, please contact: Elliot Bonomini on +44 (0) 121 661 3218 or at ebonomini@dains.com.