When growth shares need shock absorbers

Growth shares are a leveraged bet above a hurdle. In the exceptional outcome, they do exactly what they are meant to do. In a wide range of credible outcomes - where the business has performed, debt has been serviced or repaid, existing shareholders or investors have received a tolerable but unexciting outcome and jobs have been retained - management's growth shares may still be worth nil.

That is not a design flaw. It is often the design.

The problem arises when growth shares are the main retention and motivation tool for a management team expected to deliver over several years. The dead zone - the range of outcomes below the equity hurdle - cannot be ignored. And if participants are told they have ownership but are not shown the stack ahead of them, the plan is likely to disappoint even if it has been legally implemented correctly.

The answer is not always to make the growth shares more generous. Sometimes the better answer is to add a shock absorber.

The dead zone

The documents vary, but the economics are usually consistent: management only participates after a defined amount of value has been created.

In the simplest structure, that may mean value above a fixed hurdle after third-party debt has been repaid. In a more leveraged or sponsor-backed structure, the stack may also include accrued interest, investor capital, preference shares, preferred returns and PIK or other rolled-up return mechanics.

Either way, the growth shares only participate once the stack ahead of them has been cleared.

Take a sponsor-backed manufacturing business with £60m of debt and accrued interest, a further £40m value threshold ahead of the growth shares, and participation only above £100m in total. Sell at £80m, £95m or exactly £100m and the growth shares are worth nothing. Only above £100m does surplus value appear - £20m at £120m, £50m at £150m.

A £95m exit may represent meaningful operational progress. It may be a good result in a difficult market. But the growth shares are still worth nil.

That is the dead zone.

The same issue exists in a simpler company. A family-owned business might set a growth share hurdle at just above current value, say £20m. There may be no debt or preference stack. But sell at £18m, or even exactly £20m, and the growth shares are still worth nothing.

Whether the structure is a single hurdle or a five-layer waterfall, value has to clear a threshold before the growth shares see anything.

The hurdle that drifts

This is often not explained properly at the outset.

Even if the legal hurdle is fixed in the articles, the economic hurdle may drift. Debt rolls up. Preference returns accrete. Refinancing fees are added. PIK and other rolled-up returns compound. Exit timing slips.

The result is that management may need a higher exit value simply to reach the same economic participation point.

Take the manufacturing business again. The stack starts at £100m. With debt costs and preference accretion, it may become £106m by year two, £112m by year three and £118m by year four. Add a refinancing and the gap widens further.

EBITDA has grown. The strategy is being delivered. The growth share outcome still moves further away.

That is why growth shares can feel psychologically brittle. Management may be doing precisely the right things, but the incentive can still look increasingly remote.

This point does not apply in the same way to a simple single-hurdle structure. Where nothing is accreting ahead of the growth shares, the target is broadly fixed. That is one real advantage of the simpler model.

The case for a cash overlay

The company or its investors may reasonably ask: if the growth shares are out of the money, why should management receive anything?

Good question.

The answer is not to pay cash whenever the equity fails. That would be poor design. The answer is to identify the zone where the business has delivered enough to justify recognition, but not enough for the growth shares to participate.

The cash element should pay for two things: credible outcomes below the equity hurdle; and retention and delivery over a long hold period where exit timing is outside management's control.

That is not anti-equity. It is incentive architecture, meaning the guardrails matter: gate it, so there is no payment unless a minimum value, EBITDA or, in a leveraged structure, MOIC has been achieved; band it, so the plan does not create another cliff edge; cap it, so the growth shares remain the main source of upside; and align leaver treatment, so the cash and equity components tell one coherent retention story.

Two structures that work in practice

1. An exit floor bonus

Keep the growth shares for the exceptional outcome. Add a modest cash pool which pays where the business has delivered but the equity has not.

For example, growth shares participate above £100m; a cash bonus begins above £80m; it is banded through to £130m; and the cap is reached once the growth shares themselves begin to carry meaningful value.

For a senior executive, both elements might be worth nothing at £75m. At £85m, the bonus might pay £100k while the growth shares remain worthless. At £95m, the bonus might rise to £250k. At £110m, the bonus might be £400k while the growth shares have only just turned positive. By £130m, the bonus might reach its £500k cap, with the growth shares then carrying real value.

This is not disguised equity. It is a cash incentive recognising that not every successful outcome clears the equity hurdle.

Equity remains the engine. Cash is the suspension.

There is also a tax distinction. Below the hurdle, the reward is generally employment income. Above that, assuming the growth shares have been properly priced, acquired and structured, incremental value is intended to accrue through the shares and be taxed as capital. The hurdle therefore marks not only an economic inflection point, but also the point at which the primary source of reward moves from remuneration towards investment return.

2. A deferred journey bonus

Where the real issue is long hold period risk rather than hurdle level, the cash overlay can be simpler and need not replicate exit economics.

A deferred journey bonus pays an annual cash award, deferred over two or three years, with forfeiture for bad leavers, continued service and basic performance conditions.

It pays for the operating objective: stay, build, deliver.

This is particularly useful where exit timing is shareholder-controlled, market-dependent or repeatedly deferred. Phantom equity or even restricted stock may be considered, but deferred cash is usually cleaner, especially from an employment-related security perspective: no securities acquisition on grant, no growth share valuation question, no section 431 election and simpler leaver drafting. It still needs proper PAYE/NIC, accounting and governance treatment, but avoids many of the complications of another equity-like instrument.

If management cannot control when liquidity arrives, it is commercially questionable to make the entire retention proposition depend on it.

This is not for every plan

Not every growth share plan needs a cash overlay.

If the hurdle is modest, the hold period is short, the capital structure is light and management has a realistic route into meaningful value, a clean equity-only structure may be better. Simplicity has real value.

The case for a shock absorber is strongest where the opposite is true: a high hurdle, a leveraged or complex capital structure, a long or uncertain exit timetable and a material risk that credible performance produces no management equity value.

That is when the structure needs more resilience. And I do like the idea of reward resilience (read more here and here).

Tax and governance

Cash is generally employment income subject to PAYE / NICs. Growth shares are intended to deliver capital treatment on future growth, but only if the acquisition price, unrestricted market value analysis, section 431 elections, leaver terms and ERS reporting are handled properly.

Cash and equity are not economically or tax-wise the same. That distinction should be reflected in the documents and in participant communications.

On governance, the discipline is to model the dead zone before the plan is signed off. The clearest explanation is usually a simple graphic showing the debt or threshold stack, the dead zone, the cash bands and the growth share participation above the hurdle.

If people can see the economics, they are more likely to understand the risk they are accepting or asking other people to accept (read more here).

The strategic point

Growth shares are excellent at rewarding exceptional outcomes. They are often much less effective at rewarding credible ones. That is the gap a well-designed shock absorber is intended to bridge.

If a plan only pays for the top slice of outcomes, that may be entirely defensible. But everyone should understand what has been built: not broad-based alignment, but a highly geared upside instrument that, in the wrong structure, is just a lottery ticket with a vesting schedule.

At Burges Salmon, we help companies, sponsors and management teams design incentive arrangements that work across the full range of realistic outcomes, not just the upside case. That means modelling the waterfall, stress-testing the tax and leaver treatment, and making sure the plan is communicated in a way that reflects the real economics.