Exit planning – which way to go?

Exit and succession planning for the owner manager – the final piece of the business jigsaw

Alexander Wilson, Rachel Wagstaff and Thomas Slipanczewski consider the various options available to owner managers when it comes to exiting from the business, which is arguably the most significant issue facing many owner managed companies. 

Based on recent research, less than one in five UK family businesses reserve managerial positions for family members, which goes against the common perception that all family businesses are sceptical of outsiders. Often, owner managers will seek an exit from their business by growing the business and extracting value via the various routes outlined below. 

Third party sale

The combined impact of the pandemic and the anticipated rise in capital gains tax has resulted in a substantial rise in the number of shareholders looking to sell their companies. Where business owners were already approaching retirement, the pandemic might have accelerated their plans!

Many owner managers’ objective is to secure a tax-efficient sale of their business to a third party. Sometimes a trade sale may be forced, for example where there is no clear succession path for the business to pass it on to the next generation. 

There are two main structures for a sale. Owner-managers may either secure the sale of the trade and assets out of the company or they can sell their shares in the company. Each route has different tax and commercial implications, which influences the way in which the transaction is structured.

Generally, a seller would prefer to sell their shares (predominantly to take advantage of the lower capital gains tax rate by way of securing Business Asset Disposal Relief – see below), whereas the purchaser will often prefer to buy assets. In practice, there are often a few key commercial factors that will dictate the manner in which the business is to be sold, which is driven by negotiation between the buyer and seller.

Some of the key tax advantages of selling shares are as follows:

• The avoidance of a double tax charge on an asset sale, as the seller receives the proceeds of sale directly;
• Secure Business Asset Disposal Relief (previously called Entrepreneurs’ Relief) at CGT rate of 10% on up to £1 million of eligible gains (subject to meeting certain qualifying criteria), with the balance being taxed at 20%. Another relief called Investors’ Relief also enables gains on qualifying disposals to benefit from a 10% rate, for qualifying investors who subscribe for shares after 16 March 2016 and hold them for three years;
• Potentially deferring the capital gain from sale of shares by investing the proceeds in a qualifying Enterprise Investment Scheme company;
• Deferring the capital gain on disposal where the acquiring company is able to satisfy the sale consideration through the issue of shares or loan stock;
• A share sale could allow the seller to receive value for the company’s tax losses.

There are numerous tax implications to consider when it comes to selling a company and it is important that tax advice is sought with a view to structuring deals in a tax efficient manner (in line with commercial objectives), whilst taking advantage of any reliefs available. 

Management buyout

An owner-manager may want to sell shares in his or her company to the management team under a management buy-out (“MBO”), particularly where the business has a committed management team. MBO’s are often used to give the owner-manager a viable exit route from their business, particularly where a trade sale is not desirable or practicable. MBO’s usually involve the purchase of all or a controlling interest in the share capital of the owner-manager’s company. 

An MBO management team would typically structure the acquisition through a new company (“Newco”). This is generally more tax efficient as the shares in the company can be acquired by Newco, which can be via external borrowing. On the other hand, if the management purchase the business personally, this would involve significant personal borrowing, which would need to be repaid from highly taxed income extracted from the company by way of salary or dividends.  

Company purchase of own shares

Companies are able to purchase their own shares in certain circumstances, which can be used as a tax-efficient exit route for its shareholders. This is particularly useful where a shareholder wishes to exit from the company and the other shareholders are unable or unwilling to purchase the shares.

Under this route, the shareholder sells the shares to the company which are subsequently cancelled. The company must fund the purchase via its cash reserves and it must have sufficient distributable reserves equivalent to the value of the shares bought back. 

Where the shareholder receives from the company more than what they paid for the shares, the profit element is treated as a distribution subject to income tax rates. However, special rules apply to treat the profit element as a capital receipt, subject to the lower capital gains tax rates. The difference between the tax rates for income distributions and capital gains is as significant as ever and obtaining a capital tax treatment could reduce the applicable tax rate by up to 28.1%. 

Capital treatment can only apply to unquoted trading companies. Another key consideration for capital treatment is that the buyback must be wholly or mainly for the benefit of the trade. A company purchasing shares from a shareholder looking to exit the business should fall within the definition of ‘benefit of the trade’. There are other statutory requirements and advice is vital to ensure that were possible, capital treatment is obtained. An advanced clearance process is available to obtain assurance from HMRC, prior to undertaking the buyback, that capital treatment is available. It is recommended that shareholders considering a share buyback should make use of the clearance route, which ETC Tax can assist with.

Employee ownership trusts 

An Employee Ownership Trust (“EOT”) is a special form of employee trust which was introduced by the Government in 2014 to encourage and support employee ownership of UK trading companies, via an indirect holding.

EOTs are an alternative form of company exit for shareholders and are designed to offer a tax-efficient and quicker alternative to a more traditional or conventional exit route. Briefly, the mechanics are:

• A qualifying EOT will be established with a corporate trustee;
• The shareholders will sell their shares to the trustee company under a share purchase agreement;
• The company will make contributions to the EOT via trading profits each year and the EOT will use these contributions to repay the outstanding purchase price that it owes to the shareholders.

Subject to meeting certain qualifying conditions, an EOT structure can provide a number of generous tax advantages to shareholders and employees, as follows:

• The sale of shares to the EOT will be free of Capital Gains Tax where a controlling interest (i.e. majority of shares) is transferred into the EOT;
• Employees of the company can receive annual bonuses of up to £3,600 per tax year, free of Income Tax (NIC still applies), with any excess over £3,600 being fully chargeable to income tax;
• The disposal of the shares to the EOT by the shareholders is an exempt transfer for Inheritance Tax purposes.

The precise exit route for an owner manager will depend on various commercial factors. At ETC Tax, we have specialist experience of working with business owners to help them implement an exit plan in line with their commercial objectives.