There are several common exit routes for a typical owner managed company.
Either the business is passed on to children, sold on to a third party or sold out to its management team or other existing shareholders.
Impending retirement often focusses attention on exit planning, though planning well ahead of this is recommended.
In this article we will focus on selling to a management team – the Management Buy Out (MBO).
Typically in an MBO, the management team will not have the cash to fund the buy out of existing shareholders. Funding the purchase of shares personally would be hugely tax inefficient as the individual would have to find the funds from post tax income. The only entity that can generate the necessary funds will be the company itself.
The MBO can be organised in one of two ways.
Company Purchase of Own Shares (CPOS).
There are several disadvantages of the CPOS route:
- From the vendor’s point of view, unless certain tax and company law regulations are followed, the monies will be treated as a dividend and will not qualify for Entrepreneur’s Relief.
- Particularly if the sale involves selling more than 50% of the shares in the company, the company is unlikely to be able to afford to pay it all immediately.
- Payment by instalments is not impossible but it does create hurdles from both a tax and company law viewpoint.
New Co Option
In this scenario a new company, “New Co”, is set up which is owned by the management team. New Co then buys the old company, “Old Co”, usually issuing new shares to continuing shareholders and cash or loan notes to the departing shareholders. New Co is the parent company, owning a trading subsidiary, Old Co. New Co can pay off its debt to the departing shareholders in stages from the profits made by Old Co which are fed into New Co after suffering only Corporation Tax.
Like the CPOS route, there are issues to be addressed to ensure that the outgoing shareholders can qualify for Entrepreneur’s relief on the deferred consideration , the time period over which the funds are extracted , the consequences if New Co fails and the impact on IHT planning.
The disadvantage of the New Co route is that it is necessary to administer a second company. Sometimes the structure can be simplified by moving the trade into New Co but this can create practical and commercial difficulties.
That said, it offers much more flexibility than the CPOS route when it is necessary to pay the outgoing shareholders over an extended period of time.
Every case is unique and objectives vary. Thus both solutions have their merits and there are other alternatives. The real key to tax efficient exit planning is to give it due consideration as early as possible.
If you would like to discuss your exit strategy please call Graham Buckell on 01332 365855 or email grahamb@batesweston.co.uk or contact your usual Bates Weston partner
This advice is general in nature and you should take no action without consulting your professional advisors.