Can I use a Merger Reserve in my transaction ?

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Hi everyone, 

I am hoping someone out there has the right experience and knowledge to be able to guide me in this ........

Client owns 30% of a company - the other 70% is owned by an American undertaking. The American undertaking has decided it wants out and my client has agreed to buy them out. The lawyer advising my client suggested that the best option for doing this was to incorporate a new holding company and for that company to buy the shares of both parties. This is the route therefore that has been pursued. 

The existing business has 1,700 issued shares of £1 each - the American investors therfore own 1,190 shares and my client the remaining 510. 

It has been agreed that my client will pay the Americans £10,000 for their 1,190 shares. My client will receive shares in the new company (1 for 1) in exchange for his shares (so no cash being exchanged for his shares - its all on paper). 

In the holding company therefore, the acquisition cost of ALL the shares is being shown as 10,000 / 70 x 100 = £14,285 (it seemed logical to value my clients shares in proportion to the agreed price for the other 70%). 

On the books of the Holding Company therefore, there will be an investment of £14,285 in the original company at cost - issued shares of £510 being 510 shares of £1 each issued in exchange for my clients shares - the question is about the rest. 

Our solicitor has suggested that we can credit the balance to a Merger Reserve (as opposed to Share Premium or anything else). I am aware of the Companies Act rules that allow for the excess of consideration above nominal value for shares acquired to be credited to a Merger Reserve where there is a share for share exchange. For the part of the consideration that relates to my clients shares therefore, that seems fine (as he is exchanging shares for shares). My question is whether that equally applies to the premium paid for the shares bought from the Americans for cash ? Can that also be credited to a Merger Reserve or does that get accounted for as Share Premium with all the restrictions that apply for a share premium account ? (My sense is that it cannot and should be dealt with separately but I a not sure........)

Also ............ there is a significant share premium sitting on the balance sheet of the company being bought out - this resulted from the original acquisition of its shares by the American Investors some years ago (the shares that are now being bought out). At the moment that is just sitting there as I don't think we can do much with it. I gather however that we could apply to the Court to do a capital reconstruction of that company and thus convert the share premium into distributable reserves - the lawyer tells us that will cost around £3k in fees. That to me seems a reasonable investment to convert all those reserves (circa £80k) into distributable reserves, especially as the P&L reserve is negative (circa £60k) at the moment and this would clear all of that, thus allowing for dividends to be paid more quickly into the future (otherwise on current trends, it will take a couple of years to wipe out those accumulated losses and the Share Premium will still be sitting there anyway) . Might there be other options for that in this scenario which I have overlooked ?? Presumably, even if the client chose not to go down the reorganisation route today (he's not keen on paying the fees - false economy but there you go IMHO), that can still be done down the line ? 

Thanks so much in advance for all your help and insights 









Replies (3)

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John Toon
By John Toon
19th Nov 2020 11:42

I can understand the reasons for using a new hold co to facilitate the change in ownership - comments on negative reserves. I think the legal advisor is right as s612 would appear to work in this instance.

Where they are wrong though is in relation to the need to apply to the court for a capital reduction. You can do this reasonably easily using the normal procedures included in CA2006. It also begs the question that if you're already considering doing this post transaction, why not do it pre-transaction and then do a share buy back?

Thanks (1)
Replying to johnt27:
By Syd
19th Nov 2020 12:50

Hello John and thank you for responding.

In all honesty, I wasn't aware that we could affect a capital reorganisation ourselves (i.e without a Court and /or solicitor) and it's for this reason that my client is a little reticent. Inasmuch as we can do it ourselves, then yes I would agree that it's a "no-brainer" and just needs doing - in which case I will happily check the Act and get on with it (would be a great time saver if you know which sections I need to look at to get the rules).

Do you know where I stand on the first point (and the object of the post) ref. the Merger Reserve and whether I can apply this to the whole transaction or just the bit that involves a share exchange ?

Thanks once again :-)

Thanks (0)
Replying to Syd:
John Toon
By John Toon
19th Nov 2020 13:43

Hi Syd,

Link to the legislation:

I think you could use the Merger reserve for the whole transaction, although this may be moot now?

Thanks (0)