Selling Your Company: Is The Answer Staring You In The Face?

 

The purpose of this article is to provide guidance to those who may be looking to sell their business in the foreseeable future, or professionals who are advising those who are in this position. The most difficult part of arranging the sale of a business, and the reason why business brokers seem to make so much money on successful deals, is finding a suitable purchaser. 

 

Particularly if the business is in a niche industry, where there are very few other businesses with expertise, it can be very difficult to match the needs of the business owners (who wish to sell out and do something else, or take it easy) with the interests of another business, which may or may not be ‘on the acquisition trail’.

 

Looked at overall, third-party acquisitions of businesses very often fail to achieve the commercial objectives that they should. The purchaser either bungles the operation of the business following acquisition, or ‘asset strips’ it, with loss of employment. 

 

For all these reasons, the management buyout (MBO) option can often be a very attractive alternative to a sale to an outsider. 

 

Well, for a start, if there is somebody in a senior post in your company, who knows the business well and is a capable sort of person, the big advantage of an MBO is that you have a ‘captive audience’, so to speak. That is, the purchaser is (possibly literally!) staring you in the face. Many months, or even years, of possibly fruitless searching for an appropriate purchaser can possibly be avoided if your senior managers can be made to see that there are huge potential upsides to their succeeding you as the business owner. 

 

Secondly, if you find the purchaser on your own doorstep in this way, you may well be able to avoid the substantial broker’s fees (sometimes quite a large percentage of your sale proceeds) that are customarily charged by the corporate finance people. 

 

This isn’t to say that business sale brokers don’t earn their money. Finding a suitable purchaser, as I’ve said, is a very difficult task; and the ability to package and structure a sale in a professional way isn’t given to every business owner. Add to that the chanciness of any such deal, and you may well conclude that business brokers do indeed earn their money. But if you can find the purchaser yourself, in your own building, then clearly a very substantial cash outlay on sale can be avoided.

 

Very often, in practice the legal fees associated with drawing up the contract can be reduced because unlike Megabucks plc, your managers are likely to take a lot as read in the contractual documentation. On the same basis, the need for a detailed and expensive ‘due diligence’ process is not likely to be there because most suitable managers in this sort of situation will already know all the wrinkles of the business. Saving on ‘due diligence’, of course, is an advantage for the purchaser rather than the vendor; however, this in itself could be reflected in the agreed price, and the upheaval and time spent by your own accountants on feeding the information through to the purchasers’ investigating accountants can be quite a large number.

 

What’s more, when you are selling to your own managers, who have probably traditionally been used to defer to you as ‘the boss’, you may well find that you have greater influence, in practice, in how the sale arrangements are agreed. For example, you may have more influence over the important question of whether you need to stay on yourself, working for the business, for a period after the sale, and for how long.

 

The big problem, of course, typically, is the fact that the managers will have little or no cash resources to pay you for the business. They may be able to borrow some (or very exceptionally, all) of the purchase price from the bank, but more often a substantial proportion (or all) of the price is effectively going to have to be met out of the future profits of the business itself. 

 

In this situation, there is a major capital gains tax (CGT) problem to be solved. This problem derives from the general rule that CGT is chargeable in full for the tax year in which the contract of sale takes place – regardless of any deferral of the actual receipt of cash. So, if you simply agree to sell your business for £1 million, with the managers paying you 10% of this, or £100,000, each year out of the future profits, you have a problem in that the full tax on the £1 million is due on 31 January following the tax year in which the sale contract is concluded. Should the purchasers fall behind in their payments you could even, in principle, end up with more tax to pay than immediate money in your bank from the sale.

 

A good way of getting around this tax problem is for the managers to set up an acquisition vehicle, being a limited company, which acquires the shares in the target company in exchange for the issue of shares or, more frequently, loan stock. Subject to getting the appropriate clearances from HMRC in advance, this means that the gain on sale can be held over against the loan stock and will only become payable as tax in the years in which the paper turns into cash, by way of redemption of the loan stock.

 

Commonly, the loan stock will be secured legally against the shares in the target company so that, in principle, if the acquisition vehicle defaults on its obligations to redeem the loan stock, the vendor can take his shares back. 

 

But the CGT rules haven’t finished with you yet. There is often the thorny problem, under the paper for paper option, of entrepreneurs’ relief. 

 

Where a gain is rolled into paper in the way described, the tax doesn’t fall due on sale, as I’ve said, but only on redemption of the paper. However, the question of whether entrepreneurs’ relief applies will also be deferred, to the time when the paper is redeemed. If the previous owner of the business doesn’t meet the qualifying conditions in respect of the acquisition vehicle, entrepreneur’s relief could be lost, and you could end up paying twice as much tax as the theoretical liability that would have applied if you had sold the business for cash. Entrepreneurs’ relief results in a tax charge of 10%, whereas the tax charge will normally be 20% where entrepreneurs’ relief isn’t available. It is for this reason that the legislation gives you the ability to waive the ‘paper for paper’ relief and pay tax as if you had received cash.

 

A better solution than this, however, would be securing that you do qualify for entrepreneurs’ relief in respect of the acquisition vehicle itself. Apart from the requirement that this acquisition vehicle be a trading company or the holding company of a trading group, you also have to own at least 5% of the shares and voting rights and be an officer or employee of the company – and these criteria have to be met, normally, for one year prior to each relevant redemption of that company’s paper for cash. 

 

So, things can get quite complex, and this is very much a case of ‘don’t try this at home’. Advice from those used to drawing up the relevant paperwork to preserve both your entitlement to the shares in the event of default and securing entrepreneurs’ relief where appropriate on redemptions, is essential.