Hurdle Shares in the UK: How They Work and How to Set Them Up

Looking to reward key people for growing your company without giving away equity for free? Hurdle shares could be a smart, tax‑efficient way to align incentives with genuine value creation.

In this guide, we’ll explain what hurdle shares are, when they make sense for small businesses, the legal and tax steps to set them up properly, and common pitfalls to avoid. We’ll keep it practical and plain‑English so you can decide whether hurdle shares fit your growth plan.

What Are Hurdle Shares?

Hurdle shares are a type of “growth share”. They only participate in value above a predefined threshold (the hurdle). That means the holder gets a slice of future growth, but not the value that already exists in the company on the day the shares are issued.

Here’s the core idea in simple terms:

• You set a hurdle (for example, today’s market value of the company or a higher performance target).
• You issue a special class of shares that only share in proceeds above that hurdle (e.g. on sale, IPO or dividends).
• If the company doesn’t grow beyond the hurdle, the hurdle shares have little or no value. If it does, holders share in the upside.

This structure is popular because it aligns rewards with performance. It also helps founders protect “pre‑hurdle” value while still offering compelling upside to senior hires or advisers who help the business scale.

When Do Hurdle Shares Make Sense For Small Businesses?

Hurdle shares tend to work best where you want to incentivise growth but avoid over‑diluting existing owners. Common scenarios include:

• Hiring a senior leader who will directly drive revenue or enterprise value and expects meaningful equity upside.
• Retaining key contributors who have already proved their impact and you want to lock in for the next phase.
• Post‑seed/pre‑Series A companies looking for a growth‑aligned alternative to options or bonuses.
• Businesses nearing exit that want to motivate a management team to push the sale price above a target level.

If you’re still deciding how to split equity generally, it’s worth revisiting how you allocate shares and how you’ll manage future share dilution. Hurdle shares can complement those decisions by reserving pre‑hurdle value for founders and early investors while motivating growth.

Also ask yourself whether hurdle shares are the right tool compared with alternatives such as EMI Options (which can carry attractive tax reliefs) or cash bonuses tied to performance. We outline the key differences later in this guide.

How To Set Up Hurdle Shares Legally (Step‑By‑Step)

Because hurdle shares are a distinct class with bespoke rights, you’ll need to follow a proper Companies Act process and keep clean documentation. Here’s a typical sequence.

1) Map The Commercial Terms

Start with the business logic. Agree and document:

• What the hurdle is (e.g. a fixed number, today’s fair market value, or a formula linked to performance).
• When value is measured (on exit, on dividend, or both).
• How to calculate participation above the hurdle (percentage, waterfall, or ratchet).
• Whether there is vesting and any good/bad leaver rules.

Clarity up front avoids expensive disputes later. If you expect the equity to vest over time or upon milestones, put the schedule in writing – our explainer on vesting periods sets out common structures.

2) Create The New Share Class In Your Articles

Hurdle shares are almost always a new class of share with bespoke rights. To create them:

• Amend your Articles of Association to insert the class description and rights (e.g. entitlement above the hurdle, voting, dividends, leaver provisions).
• Pass a shareholder resolution approving the adoption of the new Articles and the new class. This is typically a special resolution (75% approval).
• File the new Articles and resolution at Companies House (usually within 15 days of passing).

Class rights should also address what happens on a sale (e.g. whether holders must accept a buyer’s terms under drag‑along rights) and whether hurdle shares carry any voting or dividend rights before the hurdle is met.

3) Deal With Pre‑Emption And Board Authority

Before issuing new shares, check your existing Articles and any Shareholders Agreement for pre‑emption rights. If statutory pre‑emption rights under the Companies Act 2006 apply, either honour them or disapply them by special resolution in accordance with your constitution.

Make sure the board has authority to allot new shares of the new class. If not, obtain shareholder approval (often by ordinary resolution) giving directors authority to allot the relevant number of shares.

4) Allot The Hurdle Shares And Update Records

Once authorised:

• Have the board approve the allotment and issue the shares.
• Complete a Share Subscription Agreement with each recipient, recording the price paid and terms.
• Update the register of members, share certificates, and your PSC/registers as needed.
• File form SH01 (Return of Allotment) with Companies House and update the statement of capital.

5) Put The Complementary Agreements In Place

To avoid uncertainty down the track, it’s wise to implement or refresh:

• A Shareholders Agreement covering decision‑making, transfers, leaver outcomes and exits.
• A Share Vesting Agreement if vesting or milestone‑based vesting applies to the hurdle shares.

Avoid generic templates – these documents need to reflect the custom hurdle mechanics and your cap table. Clean drafting now can save real money during diligence or exit later.

6) Keep HMRC And Companies House Compliant

Where shares are issued to employees or directors, they generally fall under HMRC’s Employment‑Related Securities (ERS) regime. You’ll need to register an ERS “scheme” for your company on HMRC’s online services and make the required annual ERS returns by 6 July following the end of the tax year, even if no tax is due. We cover the tax points in the next section.

Tax And HMRC Rules To Watch

Tax is often the make‑or‑break factor for growth equity. Get it right early and you can avoid unexpected PAYE or NIC exposure. Here are the main UK tax considerations (high‑level and in plain English).

Employment‑Related Securities (ERS)

If your recipients are employees or office holders (including directors), the shares are “employment‑related securities” under Part 7 of ITEPA 2003. Practically, this means:

• Tax on acquisition: If shares are acquired below their actual unrestricted market value (UMV) on the date of acquisition, the discount is usually taxable as employment income, potentially via PAYE. Hurdle shares are often deliberately structured to have a low initial value, but you still need to assess and document that value.
• Restricted securities rules: If the shares are subject to forfeiture (e.g. on leaving before vesting), they’re “restricted securities”. A section 431 election (by employee and employer within 14 days) can elect to tax on the unrestricted value now to avoid income tax on later growth attributable to the lifting of restrictions. This is a key planning point – get advice before issuing.
• ERS registration and returns: You must register the arrangement with HMRC and file annual ERS returns by 6 July after the tax year.

Valuation And The Hurdle

The credibility of your hurdle share valuation underpins the tax treatment. HMRC will look for a supportable valuation of:

• The company’s UMV on the grant date (often with a minority/illiquidity discount for small stakes).
• The value (if any) attributable to the hurdle shares, considering they only participate in value above the hurdle.

While you don’t need HMRC pre‑clearance to issue shares, a defensible valuation file (and, where relevant, a third‑party valuation) reduces risk in the event of enquiry.

Future Gains

Assuming the tax on acquisition is correctly handled and any 431 election is made where appropriate, future growth in value may be subject to Capital Gains Tax (CGT) on disposal (e.g. on an exit), which can be more favourable than income tax. Eligibility for Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) is often limited for minor shareholdings and non‑voting shares, so don’t assume relief will apply – get tax advice tailored to your cap table and class rights.

EMI Options vs Hurdle Shares

For many early‑stage companies, EMI Options can deliver stronger tax advantages (subject to eligibility limits), board control over timing, and clean leaver treatment. Hurdle shares, on the other hand, put recipients on the share register immediately and can be simpler commercially where you want them to be shareholders now, not option‑holders. The right choice depends on your funding roadmap, headcount growth, and how you want to manage dilution and control.

Common Pitfalls, Alternatives And Practical Tips

Because hurdle shares combine company law, tax, and bespoke drafting, it’s easy to miss something. Here are the traps we see most often – and how to avoid them.

1) Unclear Or Unworkable Hurdle Definitions

If the hurdle formula is vague or based on metrics you don’t actually track, you invite disputes just when you least want them (e.g. at exit). Tie the hurdle to clear, auditable metrics (enterprise value on sale, audited EBITDA, or a stated price per share) and include worked examples in your term sheet or class rights.

2) Forgetting Pre‑Emption And Authority To Allot

Issuing shares in breach of pre‑emption or without proper authority can be voidable and create investor headaches. Check your Articles and any Shareholders Agreement and follow the right approvals process, including any special resolutions for Article changes.

3) Missing HMRC ERS Obligations

It’s surprisingly common to issue growth shares, then forget to register an ERS scheme or file returns. HMRC can levy penalties for late filings. Put a calendar reminder for 6 July and assign internal responsibility for ERS compliance from day one.

4) Underestimating Dilution And Exit Mechanics

Growth shares only participate above the hurdle, but they still dilute other holders in that range. Model different exit prices to understand who gets what. Make sure your exit terms (including drag‑along rights) work with your hurdle class so a buyer can acquire 100% cleanly.

5) No Vesting Or Leaver Provisions

Issuing equity without vesting or leaver rules can leave you over‑exposed if someone leaves early. Build vesting into your class terms or use a tailored Share Vesting Agreement. Good/bad leaver clauses should be crystal‑clear and aligned with employment contracts.

6) Ignoring Alternative Tools

Hurdle shares are powerful, but they’re not the only way to align incentives. Depending on your priorities, consider:

• EMI Options for tax efficiency and flexibility (subject to eligibility).
• Non‑EMI options or phantom equity for simpler administration.
• Cash bonuses tied to audited performance where equity isn’t appropriate.

If you prefer to keep people off the cap table until an exit is certain, options often win. If you want recipients to be shareholders now and share immediate governance rights, growth shares could be the better fit.

7) Not Exit‑Proofing The Paperwork

Buyers scrutinise incentive equity on due diligence. Incomplete filings, ambiguous class rights, or missing consents can depress your price or derail a deal. Keep a tidy data room: amended Articles, board minutes, shareholder approvals, subscription documents, valuations, ERS filings, and cap table reconciliations. The earlier you get this in order, the smoother your exit process will be.

Practical Setup Tips

• Use plain language in class rights and include examples so future readers interpret them the same way.
• Document your valuation assumptions and attach the working to the relevant board paper.
• Model different exit prices to check the waterfall works the way you think it does.
• Line up your investor consents early if your Articles or investor rights require it.
• Sense‑check the cap table after allotment to ensure totals and class balances are correct.

Key Takeaways

• Hurdle shares are “growth shares” that only participate above a set threshold, aligning rewards with performance while protecting existing value.
• To implement them lawfully, amend your Articles to create the new class, obtain the right shareholder approvals, respect pre‑emption, allot the shares, and file on time with Companies House.
• Where employees/directors receive shares, the Employment‑Related Securities rules apply: handle acquisition tax, consider a 431 election for restricted shares, register an ERS scheme, and file annual returns.
• Keep the paperwork tight: use a clear Share Subscription Agreement, maintain or update your Shareholders Agreement, and apply a tailored Share Vesting Agreement where vesting or leaver outcomes apply.
• Compare hurdle shares with EMI Options and other alternatives to choose the most tax‑efficient, scalable incentive for your stage and strategy.
• Avoid common pitfalls like vague hurdle definitions, missing ERS filings, or ignoring dilution and exit mechanics – they can be costly at diligence or exit.

If you’d like tailored help designing or implementing hurdle shares – from drafting class rights and agreements to HMRC compliance – you can reach our friendly team at 08081347754 or team@sprintlaw.co.uk for a free, no‑obligations chat.