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Mergers & Acquisitions – Shareholder Transactions

The tax consequences and considerations for individuals who are selling part, or all, of their business

If you are an entrepreneur or founder, your business is likely to be your most valuable asset resulting from many years of hard work.

If you are now considering a sale, this is likely to be the most important financial event of your life so far.

Whether you are thinking about a complete disposal or a partial exit, the process is likely to be time consuming, stressful, at times frustrating, and you’ll still need to ensure that you’re focussed on the performance of the business throughout this critical period.

Tax is almost always the highest cost for shareholders on a transaction and understanding your tax position, and that of any employee shareholders, is very important.

We are passionate about advising business owners on the tax implications arising from selling, refinancing and restructuring their businesses. Our dedicated transactions team have decades of experience in supporting business owners throughout this critical journey.

Small Business Selling A Business

The business sale journey

  • 12-24 months before exit
  • Exit process – 2 divergent paths here being:
  1. Sale to Trade
  2. Sale to Private Equity
  • Re-join to Post Disposal – compliance obligations
  • Post Disposal – What next?

Selling A Business Handshake

What to think about before a transaction process

If you are in the early stages of thinking about selling your business, there are important to things to think about from a tax perspective including:
  • What tax reliefs are available to the selling shareholders? Is everyone going to get the relief they think they will be entitled to? If not, what can we do?
  • Are there any investment assets that need to be separated from the business before a sale?
  • Are your management team properly incentivised for this deal and beyond? Do the right people have the right shareholdings?
  • If you have a share or share option scheme, does it work as you hope? A lot of energy is often expended on transactions rectifying issues with tax-advantaged EMI share option schemes – reviewing these early can make a material difference to the outcome.
  • Inheritance tax (“IHT”) – Shares in a private business may qualify for various reliefs – do any shareholders want to consider trusts or other personal holding companies?
  • Residence advice – Are any shareholders non-UK resident or considering becoming non-UK resident?
  • US – Are any of your shareholders US taxpayers? Even if US citizens or greencard holders are UK resident, they still need to consider their position in the US.
  • Business reviews – Are there any tax risks in the business that can be addressed in advance of the transaction process, to avoid difficulties when potential buyers undertake a due diligence?

Selling to a trade buyer

No two transactions are identical but sales to trade buyers tend to include

  • an element of cash consideration;
  • an earn-out; and
  • occasionally a reinvestment into the shares of the buyer.

The expectation of sellers is that they will be subject to UK capital gains tax (“CGT”) on the receipt of cash. Generally CGT will be payable at 10% where business asset disposal relief (“BADR”) is available or 20% where it is not. It will be important to ensure that the cash proceeds received are subject to CGT and cannot be recategorised as employment income.

Selling To A Trade Buyer

The tax treatment of earn-outs can be complex. Firstly, it will be critical to ensure that earn-outs are subject to CGT, not employment taxes – essentially that they represent consideration for the business and not reward for services.

Once it is clear that the earn-out should be subject to CGT, it will then be important to consider the timing of the payment of CGT liabilities – here it will be critical to determine if the sums received are ‘ascertainable’ or ‘unascertainable’. The tax rules in this area typically result in individuals paying tax on earn-outs in advance of their receipt, even if they are wholly contingent (i.e. may not even be received). It may therefore be necessary to consider structuring earn-outs using loan notes to align tax payments with the receipt of cash.

Our dedicated transactions team have extensive experience of advising on trade sales – please click here to contact a member of the team.

Selling to Private Equity (“PE”)

High level, what does a UK PE deal look like?

Most disposals to UK PE tend to be structured in a similar way. The most typical structure involves a stack of 3 newly incorporated UK companies – this is often referred to as a “triple Newco structure”.

The parent company in the structure tends to be referred to as “Topco”; Topco will hold 100% of the share capital of another UK company (“Midco”); and Midco will hold 100% of the share capital of the company which will actually make the acquisition, which is generally referred to as “Bidco”.

This three-tier structure is favoured because it facilitates a clear separation between different providers of capital – Bidco will typically raise debt finance from a traditional bank, with Midco being utilised to raise additional debt which is subordinate to the bank debt. Topco is the entity in which the Investors and management will hold their ownership interests.

PE Business Sale

The consideration payable to shareholders in a PE transaction tends to comprise:

  • cash (payable by Bidco)
  • loan notes or preference shares issued by either Midco or Topco; and
  • ordinary shares issued by Topco

Shareholders who are completely exiting will generally be paid out in full. Reinvesting shareholders (generally the management team) will receive cash plus shares and securities in the new structure. Reinvestments vary but typically are between 40-60% of gross proceeds.

Management will reinvest most of their proceeds on the same terms as the PE house – this investment is often referred to as “Strip” and comprises both ordinary shares and loan notes/ preference shares in an agreed ratio such that if £100 is invested, an agreed % will go to acquire ordinary shares and the remainder to buy loan notes or preference shares. This varies deal to deal typically from 99%/1% (i.e. £99 invested in loan notes/ preference shares and £1 in ordinary shares) to 90%/10% (i.e. 90% invested in loan notes/ preference shares and 10% in ordinary shares).

The preference shares/ loan notes will have a coupon attached and will rank ahead of the ordinary shares. Hence the ordinary shares don’t have any value until the principal value of the loan notes or preference shares and the accrued coupon has been paid out.

Generally, there will also be an allocation of “Sweet Equity” for management. Sweet Equity is the acquisition of ordinary shares with no accompanying loan notes/ preference shares. As there is no requirement to also buy preference shares or loan notes, the ordinary shares can be acquired more cheaply as part of the Sweet Equity than if they are acquired as part of the Strip. This means that the return profile on the Sweet Equity is very different to the Strip – It is not uncommon for management to make a return of many multiples of their original investment in respect of the Sweet Equity where the business performs well, whereas return multiples on the Strip will be lower. However, the Sweet Equity is highly ‘leveraged’, which means that if the business does not perform well, management may not realise any return on their Sweet Equity.

Selling to Private Equity – What are the high-level tax issues?

Ensuring that UK capital gains tax (“CGT”) is payable on the receipt of cash.

Generally, CGT will be payable at 10% where business asset disposal relief (“BADR”) is available or 20% where it is not. Where shareholders reinvest into the new structure, it will be necessary to consider the transactions in securities (“TiS”) legislation which can re-categorise capital proceeds as income for UK tax purposes – the TiS legislation and exemptions to this legislation will need to be carefully considered. It may be appropriate to seek clearance from HMRC. In addition, it will be necessary to ensure that the employment tax legislation cannot re-categorise the proceeds as employment income.

How you can reinvest / rollover into the new structure including:

  • Whether “Rollover Relief” will apply, or the transaction can be structured so that it applies. Rollover Relief allows a tax-free reinvestment into the new structure. Shareholders may also wish to consider not seeking this relief where there is an expectation that tax rates may change, and shareholders want to “bank” current CGT rates.
  • Comparing the tax treatment of reinvesting into loan notes or preference shares in the new structure.
  • Whether or not advance statutory clearance should be sought in relation to Rollover Relief.

Other relevant tax considerations for Management in respect of the proposed Newco capital structure including:

  • The “employment-related securities” legislation (“ERS”). This legislation generally applies whenever employees or directors acquire shares/securities in their group and can result in employment tax charges arising on acquisition or later disposal of these securities.
  • In relation to the ERS legislation, it will be necessary to consider whether the Transaction could meet the conditions set out in the Memorandum of Understanding (“MOU”), a concessionary position where HMRC will agree that Management have acquired their Sweet Equity shares for a market value price (meaning that no employment tax charges should arise).
  • If the Transaction is not within the MOU, advice in relation to whether a tax valuation should be sought to determine market value.

Where appropriate, taking steps to mitigate management’s exposure to inheritance tax.

How we can help

The tax position of the shareholders on a PE transaction is not generally straightforward.

Our dedicated transactions team focus on advising shareholders selling and restructuring their businesses.

Post disposal – your compliance obligations

Following the disposal of your shares, you will need to ensure that you accurately complete your tax return. We are always happy to help with tax return completion if you don’t already have an advisor or, alternatively, to prepare disclosures for your own advisors to use to complete your tax return.

Post disposal – what next?

Once you have realised your proceeds, you will invariably want to think about how to invest those funds. Tax efficiency should never be the reason for making an investment but equally it is critical to understand the tax implications of any investments you make and also to consider the most tax efficient way to hold your investments. Our team can help you understand the tax issues associated with the investment of your proceeds and what other advice you may need.

Contact Genevieve

Genevieve Morris
Genevieve Morris
Partner, Head of Corporate Tax
View Genevieve's profile