David: Today we're just going to try and look at the journey through which an owner-manager might go through on the sale of a business, and a couple of other tax aspects that might come out at different junctures. So Leigh, just to start with then, if a client is thinking of selling their business in the next two to three years, what would you be raising with them, in terms of incentivizing staff to maximize the value of the business on an exit?
Leigh: An important thing to remember and think about is the position of the staff. The owner is selling and they're pulling out of the business, but of course there are people working there and it can be destabilizing for them. But it's also a very good opportunity to incentivize the people who work in the business to help boost the value of it, and make it as attractive as possible to any buyer. There are good opportunities to do this, especially for the entrepreneurial type trading businesses.
Leigh: And the best way is really to link the rewards and the bonuses to employees to the actual value that it has achieved on a sale; and the most efficient way to do that is if you can get across the value as a capital gain for the employee, because the tax rates are generally lower for them. So share type incentives work very well. If the owner is not necessarily wanting to give away the business at this stage, options for shares can be given to employees. These can be linked to a sale so that if the sale goes ahead, that's when they crystallize. At that point the value is there.
Leigh: Although it seems odd to think giving away part of the business is good for the owner, of course, if the rewards are linked to performance, then the more value there is in the company; although giving some of that added value away, this still leaves more for the owner.
Leigh: And these are the kind of things to incentivise two to three years in advance of a potential sale. It is well worth planning ahead for this kind of situation because the best rewards and incentives will apply the further ahead of the sale that they can be introduced. What you're wanting to look at is growth of the business really from the point that the exit is being contemplated, and the incentive being given, up to the point of the actual sale, and sharing that with the employees.
David: Right. So the incentives now say have been put in place, the value of business has grown, a potential sale is coming onto the horizon. And the entrepreneur's looking ready to sell the business within the next 12 months. On that kind of timeframe, what are the steps that they're seeking to take to optimize the position?
Leigh: There you're looking more at the seller's personal position. Hopefully they've taken steps that we've talked about to get the business in a position to sell. At this point they need to look at their personal position. For example their personal tax rates depending on the values involved, for example if the owner is running near limits on their entrepreneur's relief, which of course is what they're wanting for the best tax rate. Are there opportunities to maybe share the business with members of the family? It can be transferred to a spouse or civil partner generally with no tax consequences of doing so, but you then potentially enable the spouse or partner to also benefit from the reliefs.
Leigh: Other possibilities, if this is heading towards the last business the owner is wanting to operate, they're coming near retirement, you may want to think about planning transfers down to children because, for inheritance tax purposes, transferring an operating business can again be very efficient, either directly to the children, or maybe into a trust for them.
David: And if the buyer that's coming along is from the private equity sector, as is fairly common, what are the possible arrangements that they might want? And what happens if they want to defer some of the sale's proceeds? How do you structure the transaction?
Leigh: What you're looking at there, as I said earlier, are the employees and the business. The private equity company, the buyer, is going to want to have a business that is still running actively. What they don't want is a position that the owner has sold the business, disappeared, and a lot of the value of that business was actually related to the personal nature of the relationship of that owner to the business.
Leigh: What private equity houses are often looking for, what they want, is firstly for some of the price they're paying to be linked to future performance of the business. So they'll give a price based on the value now, but there'll be an earn-out running forwards to make sure that the business will still keep developing and growing at the rate it has done to date. It was the nature of the business that was what was attractive to them.
Leigh: The types of things they may do, is they may want to defer some of the price they're paying. They are likely to want the owner to continue through with the business for a handover period, and similarly, for some of the senior management maybe to have a tie-in with the business.
Leigh: So if previously, as suggested, you've managed to get some of the key employees actively involved in the business with shares or options in the business, what you may well be looking at doing is having the managers and the owner possibly get some cash on the sale, but then have other deferred elements of what they're receiving possibly in shares or options in the buying vehicle that the private equity house is using.
Leigh: They're good opportunities there for doing so tax efficiently. The seller can roll through into the new owning business working with the private equity house.
Leigh: But there are also certain traps here. We often work with the owner and the management team to find ways that they can get as much as possible of the proceeds tax-efficiently. Risks that would come are that, if you're getting a deferred payment and the payment is paid after the company's been sold, entrepreneur's relief might not be available. So there are ways we can work to structure around that, to get the best tax rates for the seller.
Leigh: Similarly the buyer might want the owner to stay on for a period of time afterwards. Again, we have to be careful, and we work with the owners and with the buyers to make sure that you have structural arrangements to ensure that any money they're getting further down the line is not treated as payment for staying working with the business, but is really recognized as being a part of the value on the sale. So it's not remuneration taxed as income, but it still retains its nature as being sale proceeds for the value of the business.
David: And alongside the planning for income tax or capital gains around the sale, what is it that you discuss for clients interested in looking at broader estate planning? If they're serial entrepreneurs with children or adult children, they might be motivated to think about succession issues. What is it that you look at, in the transaction linked to that?
Leigh: There you can be looking at getting some of the business to the children or into trusts for the children.
Leigh: The point here is that if you sell your business and receive a payment of cash, and you give that cash to children, or you put it into a trust, there will be potentially an immediate inheritance tax charge for putting the money into trust, or else there'll be a latent charge that you have to survive seven years, otherwise it will come back into the inheritance tax net.
Leigh: Alternatively, if you're talking about a family trading business, there may well be business property relief available against inheritance tax if the business is given away. So what may be better to do, is to transfer the actual business to the family so as to get the relief against inheritance tax. It effectively moves the value out of the owner's estate to children or grand-children, or to a trust for the benefit of the remainder of the family and future generations.
Leigh: There are going to be on-going considerations moving forwards, but it's a good starting point to have managed to transfer down the generations some of the value from the sale potentially without triggering inheritance tax on the proceeds.
David: Great. Well that was a very useful summary of all the different things that an entrepreneur might consider. The thing that comes across is the value of planning ahead. Looking at structure of incentives, looking at preparation around the sale in to minimise income tax, capital gains, and inheritance tax. Because there are clear opportunities to do something if well planned.
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