Exit Strategy

Exit Strategy

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One of the shareholder/directors of a 50:50 owned company is looking to formalise an exit strategy over the next three or so years.  The shareholders are unconnected, one director (A) is an entrepreneurial type and is looking to grow the company whilst the other, director B, is more risk averse and is in the opinion of A "holding the company back".  There is no big fallout, and things are still very amicable between the two, just differing opinions on the way forward.  As B is looking to retire in the next few (max 5) years they are now considering an exit strategy for him, in as short a period as possible.  If the company is to move forward as A wants it to, B does not want the responsibility of shareholding/directorship - he is not averse to continuing as an employee if necessary.

Here are the facts given to me so far:

A will not buy out B - his reasoning being that he would have to earn at least twice the amount of the value of the shares to pay for them (as a 50% tax payer) and he does not have the funds readily available to do this.

A does not want to work with a third party, so selling to a third party is out.

As far as I see it, this leaves the possibility of the company buying back B's shares.

B wants to clear £1m after CGT and any other costs.  His disposal would, I believe, qualify for Entrepreneurs Relief, so lets assume he needs to sell his shares for £1.2m to net £1m.  This is not far out valuation wise as a third party offered £2.25m for 80% of the company's shares last month (deal was not right for them apparently).

The company has approximately £300k in retained profits and generates on average approximately £600k net profit, before directors salaries and dividends.  The company would most likley be able to borrow funds, from a bank,  in excess of £1.5m.

They are looking to structure a deal over 3 years for B to dispose of his shares and net £1m, they are both aware of the risks of doing this in terms of, for example, the company being worth £1 in 3 years or the company being worth £1bn in 3 years. 

I have a fair knowledge of a company buying back its own shares, in simple situations, however there seem to be too many pitfalls and obstacles to make this 'simple'. 

I am therefore just looking for some pointers and/or strategies as to what is "do-able" and what is not or whether a sale to director A would be possible given the above - I am looking at this for the company as opposed to either director individually.

Apologies for the long post and any comments or pointers would be very gratefully received.

Replies (7)

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By JamesPrice
03rd Aug 2011 10:39

Apologies if this message appears multiple times! Are you saying that they want to fix a price now and get the proceeds to B over three years? I think you've correctly concluded that CPOS won't work in such a sceanrio, but could you look at inserting a holding company that could buy each party's shares, consideration for A being an issue of shares in the holding company, for B an issue of loan notes to be repaid over 3 years.

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By leestevens
03rd Aug 2011 11:02

Thanks James

That is roughly the idea, B is quite happy to net his £1m proceeds over a period of three years.  This may not be fair to one or other of the shareholders, but as of today the valuation stacks up.

I will investigate your thoughts, thanks for an excellent starting point.

 

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By petersaxton
03rd Aug 2011 21:23

Are you sure?

So the company could borrow £1.5m from a bank but the director who will be owning 100% of the shares can't borrow £1.2m?

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By leestevens
03rd Aug 2011 21:36

Sure?
Peter,

No I'm not 100% sure at present. I am just working on some preliminaries at the moment. Trying to rule out the definite no-no's and the can't do's. I will of course be giving him one option of borrowing himself, his reticence to borrow seems to stem from the belief that to pay that borrowing back he would have to earn twice that amount before tax.

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By petersaxton
04th Aug 2011 08:21

Double

He will have to pay twice the amount back but he will also be getting double the income.

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By leestevens
04th Aug 2011 09:45

Double

Peter,

I appreciate your comments, and agree with you.  As I mentioned previously, I am just trying to get some options together and evaluate which is best all round.  Part of the intial brief I had was that director A was not prepared to buy the shares as it could be done more efficiently in another way.  How he 'knows' this I am not sure (pub talk?).  Ultimately I believe he sees the high level of income tax from his 'own' income as abhorrent, whereas for the company it is just a necessary evil, hence the reticence.

I will be advising on what definitely cannot be done, what is possible and which is/are the most tax efficient and low risk approaches.  Ultimately A and B must agree the way forward between themselves.

Thanks again for your comments.

 

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By mrtrub
20th Sep 2011 06:49

Possible share reclassification

One possible way forward is to convert the shares into half ordinary, half preference, giving the exiting director a stable valuation for the firm, and placing all the risk on the other director.

This would have the advantage of not causing the firm to borrow too heavily, and the preference shares could be redeemed as desired.

Am not sure of the tax implications, but think that the share conversion would be tax free.  Suggest that you consider this as one of the options, and ask both directors what they think

 

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