Tax planning for business owners wanting to cash in from selling their business

In this article, WBR CEO and tax law specialist, Tom Moore, discusses the various options business owners have when looking to cash in and sell their business, and what tax implications need to be considered with each decision.

The enduring popularity (in some quarters) of the old song “The Gambler”, most famously performed by Kenny Rogers, probably stems from the timeless pearls of wisdom in its lyrics. “You never count your money when you’re sittin’ at the table…” Kenny sang, and that could be the mantra of any owners of a small to medium-sized business. Aside from the need for good financial management, it isn’t helpful, for the entrepreneur, to think too long or hard about the value (at any moment) of the business they are building. There may only be one occasion when that will matter.

But for most business owners, there is a hope, even an expectation, that a time will come when they can cash-in their chips and enjoy in full the fruits of what may have been decades of labour. Many may have in mind a sale of the business to a third party, but there are other ways of realising a return of value from an owner-managed business.

The tax system has for a long time encouraged entrepreneurs to accumulate value in a business and eventually sell or realise that value in another way. Generally, an exit from a business will involve a charge to Capital Gains Tax (‘CGT’) rather than Income Tax which, currently, involves a lower rate of tax in the majority of circumstances. The addition of special reliefs has added to the potential advantage. Before ‘Taper Relief’ was introduced in 1998, Retirement Relief had been available to exempt a part of any gain. Entrepreneurs’ Relief replaced Taper Relief (relying on similar concepts) and this has now been re-named ‘Business Asset Disposal Relief’ (‘BADR’). Encouragement of long-term investment has been the common ambition of all variants.

Not all – but many – business owners will over-estimate the market – both in terms of size and appetite – that exists for their business. Many face disappointment when buyers prove to be elusive or unwilling to meet the asking price.

There are other options apart from a trade sale. It is always possible for an owner to simply liquidate a company or sell off the assets of a business. But for a viable going concern, that is very unlikely to produce the best result.

Another alternative – in many cases the best one- will be a sale to management (a ‘Management Buy-Out’ or ‘MBO’). An ambitious management team can provide the perfect purchasers. Knowledgeable and skilled in the trade – and emotionally attached to the venture – a strong senior team can be ideally placed to appreciate the potential value of the business and make a success of it. Most of the MBO proceeds will be funded from future business profits (paid in the form of an earn-out or deferred consideration). This will provide an incentive for the vendor(s) to have continuing involvement but that may be less onerous than the demands of a trade buyer.

Normally, the only question will be whether management can raise the funding necessary to make any up-front payment required by the vendor. Not every business, of course, will have sufficiently skilled and motivated executives to allow an MBO to happen.

Another (and increasingly attractive) alternative involves the use of an Employee Ownership Trust (‘EOT’). This can provide some outstanding benefits for an entrepreneur selling shares in a trading company.

An EOT is a special form of employee benefit trust, borne out of a political desire in September 2014 to increase shareholder diversity and encourage employee ownership within the UK economy. It can be thought of as facilitating a ‘John Lewis’ model of business ownership.

In essence, the arrangement involves the creation of a trust for the benefit of the employees of the company. The vendor sells their shares to the EOT Trustees (usually for some cash but mainly for debt). The debt owing to the vendor is paid off by the Trustees funded from further contributions from the company out of post-tax profits. It follows that the vendor will only receive full value for the shares so long as the company remains in a position to fund contributions and so the continuing involvement of the owner-manager is likely to be necessary. But that will usually be a requirement in any trade sale (and with stricter demands).

From a (narrow) vendor perspective, it is difficult to find a flaw in the use of an EOT. In particular;

• The shares can be sold tax-free to the Trustees (subject to valuation). Since the restriction of BADR (which provides a 10% rate) to the first £1m of lifetime gains, the benefit of a zero rate has been thrown into starker contrast.
• There is no need to find a buyer and the legal process of sale is likely to be a “friendlier” experience.
• There will be no risk of HMRC seeking to charge any of the proceeds to Income Tax (if clearance is given which will usually be a certainty).
• The vendor can retain an interest in the company (up to 49%).

For the employees too, the benefits should be obvious; a pool of shares will be held for their benefit on terms that can be agreed with them. There are strict requirements concerning the breadth of benefit (and in respect of other matters) but there is useful flexibility even within those rules. Employees will be able to take some income (£3,600 per annum) tax-free.

So why would an EOT not be used?

An EOT carries with it a bunch of conditions and rules but, in themselves, these are unlikely to add up to a reason against its use. It is only really where there is a management team hungry to take on the challenge of business ownership that an EOT will not be the ace in the pack.  An EOT may not be able to satisfy the ambitions of a group of strong senior managers who will hope for a lucrative exit of their own.

Whether such a team exist will be a fact of the business at the time. If an MBO isn’t possible, then an EOT may provide a great solution.

Nevertheless, it should be borne in mind that the value that a strong management team brings is likely to be a card that will trump any of the benefits of an EOT. Driven individuals with ambition, energy, skills, knowledge, experience and networks, can propel a company to new heights. To build a strong senior team – possibly nurtured through the Enterprise Management Incentive (‘EMI’) scheme – who will eventually lead an MBO, will almost always be the best option.