EXIT STRATEGIES FOR FAMILY FIRMS
We’re often asked how to achieve succession within family businesses. For this type of business Business Exit Strategies mean how to pass it on and not how to achieve a trade sale of the company. Very often this will be done in the form of a Vendor Initiated management buyout, particularly if those who are to succeed are not just family members. The VIMBO or succession buyout structure can also work well in a family deal, if Mum and Dad want full value rather than gifting the business, and if they need some sort of carried interest or ongoing income.
SIMPLEST CAN BE BEST
That said simple is often best. And particularly in small deals variations on the share buyback theme can be useful.
We recently helped a family business in Suffolk achieve succession using this type of structure. It wasn’t a huge business, but was sustainedly profitable, and had grown to have branches in Essex, Norfolk and Cambridgeshire. Mum and Dad had been running their business as a company for many years, but had involved their two sons in the business as full time directors. As the sons took more responsibility in the business they felt that it was time for them to take control. The aim was to achieve the transfer and for the parents to have the profits which had accumulated in the company to be paid out to them tax efficiently. If the arithmetic stacks up this can be done using a buyback of shares.
The tax legislation which gives favourable tax treatment to an individual when a company purchases some of its own shares provided certain hoops are jumped through. In outline the steps are:
The sons get given some shares (a 32% minority holding) in the company a few years before Mum and Dad were ready to fully hand over the reins. Result = no tax charge for parents or children due to the availability of tax reliefs - it qualified as a trading company.
More recently, when Mum and Dad decided to retire, the company bought back their shares. This was done correctly and so the proceeds will be taxed as capital receipts for the sale of their shares (and not subject to income tax). Entrepreneurs’ Relief should be available as both the individuals and the company meet the conditions and so the tax charge is only 10%.
The company then cancelled the shares so that the shares held by the next generation are the only shares in issue and they all of the company.
THE GROUND RULES
In all deals there are some company law rules to be observed, or the danger is that the purchase of shares is an invalid purchase with unfortunate consequences. As ever there are also tax rules to follow – and they’re often not quite so clear cut. In this case the two keys matters that had to be established were that the company was a trading company for the purposes of Entrepreneurs’ Relief and that the purchase of shares is for ‘bona fide commercial reasons’. The ability to “clear” this with the revenue in advance is helpful. Of course there is usually a financing issue too. In this case the company had the cash to payout. But what if the company doesn’t have enough cash? There are ways round this – and indeed this might be a cue to consider a Newco buyout structure.