finance 45


Financing share acquisitions – the alternatives


It is not at all unusual for the purchaser of a company not to have, in readily available cash, the amount required to buy its target company, writes Katherine Cereghino of Brethertons


Broadly, the buyer has three options:- 1 Debt


Main advantage: interest on borrowing is tax deductible from profits.


Main disadvantage: repayments have to be met regardless of the financial performance of the target company.


The Companies Act 2006 abolished the prohibition on a private company giving financial assistance for the purchase of its own shares meaning the assets of the target company can be used to secure finance opening up a variety of options including bank loans and asset financing. It will depend very much on the appetite of lenders to lend to the type of business being acquired and


the type and level of security the company can offer against the loan. A company with a strong cashflow or an asset-rich company may find it comparatively easier (and cheaper) to borrow money than a company with a weaker cashflow or little or no chargeable assets.


The cost of securing the loan will also influence a purchaser’s decision as to whether this is the right option as will any restrictions on borrowing (eg because of pre-existing bank loans).


2 Equity finance


Main advantage: if properly structured, an equity deal will allow managers of the new company to be taxed under the capital gains regime and avoid income tax charge.


shareholder debt, usually in the form of loan notes.


3 Funding through the share purchase agreement – earn-out


Main advantage: benefits cashflow by deferring payment of the purchase price.


Main disadvantage: does not give the purchaser a ‘clean break’ purchase.


Main disadvantage: as shareholders, private-equity providers (PEPs) have a greater say in the running of the business than a finance lender.


For private companies, this often takes the form of a PEP injecting cash (in exchange for shares) into a company formed specifically to purchase the target, often with the managers of the new company also as shareholders. Generally, the amount subscribed by the PEP for ordinary shares, alongside management, is only a very small proportion of the money that it invests and the rest is injected as


An earn-out covers any mechanism where, on the sale and purchase of a company’s shares, some or the entire purchase price is determined by reference to the future performance of the target company. Technically this is still a form of debt but payment is deferred and, if the company does not perform well, reduced or not made at all. Earn-outs are typically used to secure the future services of a seller who is key to the target business (eg to preserve ongoing relationships with customers).


Details: Katherine Cereghino 01295-270999 katherinecereghino@brethertons. co.uk


taxation Bear traps on a company sale: Income tax


Many private company shareholders expect to pay capital gains tax (CGT) at 10% with entrepreneurs' relief on a sale of company shares. It can be a very unpleasant surprise if they find that they don’t qualify for entrepreneurs' relief or, potentially worse, have to pay income tax and NIC, writes Holly Bedford


An article published in the July/ August edition of The Business Magazine covered events that can lead to a loss of entrepreneurs' relief. This article looks at three common risk areas that could give an unexpected income tax charge on a sale.


Earn-outs


If the selling shareholders remain employed post-sale, there is a risk that HMRC will consider the earn-out to be disguised employment income assessable under PAYE with NIC, rather than taxable under CGT, with implications for the individual and the employing company.


Red-flags in earn-out clauses include:


• earn-outs only being paid to the employed shareholders;


• below-market rate salaries;


• targets based on personal performance targets; and


• the earn-out being dependant on continued employment, “beyond a reasonable requirement to stay to protect the value of the business being sold“.


Preferential share pricing


Disposal proceeds above market value


If an employee/director shareholder receives a higher price per share on a disposal than the other shareholders, which is not justified by the share class having more valuable transferable rights, HMRC may assess the excess payment as an employment reward with income tax and NIC due under PAYE.


Shares acquired at an undervalue


If an employee/director receives shares and pays less than market


THE BUSINESS MAGAZINE – THAMES VALLEY – NOVEMBER 2015


value, there is an income tax exposure for that individual. Sweet equity deals or ratchets in favour of management need careful review.


HMRC will not give advance share valuations, but a post-transaction valuation can be agreed to give certainty over the employee’s income tax position.


Transactions in securities rules


These wide-ranging anti-avoidance rules apply to closely held companies (generally controlled by five or fewer shareholders or controlled by the directors).


These rules often present a problem on Newco acquisition structures where there is a partial exit of the major shareholders for cash or loan notes, such that they are retaining a material shareholding going forward.


These rules will tax share sale www.businessmag.co.uk


proceeds as if they were a dividend, subject to income tax, rather than capital proceeds under CGT. For higher-rate taxpayers, this could mean significantly higher tax rates, particularly if the client expected to pay 10% under entrepreneurs' relief.


There is a safe-harbour where a shareholder retains 25% or less going forward, but the details of this provision need very careful review.


This can be a deal-breaker and it is crucial that vendor’s expectations are managed and that advance HMRC clearance is considered early in the sale process.


The tax team at HMT, led by Holly Bedford, provides specialist advice to shareholders, management and companies on acquisitions, disposals and corporate restructurings.


Details: Holly Bedford hbedford@hmtllp.com 01491-579740 www.hmtllp.com


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