This blog will run the risk of sounding like a script for Harry Enfield’s, ‘Mr You Don’t Want To Do It Like That’…however I think sharing this experience is a worthwhile exercise.
I get a lot of enquiries about how to structure management buy outs (MBOs), which can be complicated in their design and come with a whole host of associated tax issues. Sometimes the clients that I speak to believe that they can do an MBO on their own, and sometimes without tax advice of any kind. MBOs are in many ways like riding a bike – if you don’t know what you are doing or haven’t done it before then it’s likely you will fall off – and this was highlighted to me recently when an accountant returned to me for help on an MBO that I had looked at two years previously.
Below I set out the case in bullet points for the purposes of easier reading:
• In 2014, the client (an accountant) approached me about advising one of his own clients (a trading company and its main shareholders) about how to do an MBO with the two managers. The view from the client was that our suggested company on top structure was ‘overkill’.
• In 2015, the end client returned to us having spoken with their bank who had convinced them that the structure we had suggested was the most appropriate. However, we lost the work to another firm who, as we understand, quoted only £4k. The MBO completed in September 2015.
• The accountant had limited input into the actual MBO itself, but in November 2016 began finalising the accounts for the accounting period in which the deal happened. They asked us to look at the sale and purchase agreement, as the sums in the consideration schedule did not appear to add up and, at this point, we asked a number of questions giving rise to the following observations/issues:
• The adviser who was engaged, advised on corporate finance matters only, did not give tax advice – this meant that the client compared ‘apples with pears’ when assessing his advisers.
• In addition to not adding, up the consideration stated in the SPA, appeared to shift a material amount of value from the vendors to the incoming management team which would be subject to income tax. Further discussions established that the parties, including the two lawyers and the two corporate finance advisers involved, had not thought very hard about the valuation to be used and how it interacted with the mechanics of the MBO. They had omitted to consider whether their proposed mechanics resulted in value being shifted from the vendors to the management team and whether the vendors should have received additional preference shares (for example) to ensure that no current value was shifted from them to the incoming shareholders.
• Because of the uncertainty around the genuine value of the shares stamp duty was probably overpaid by in the region of £1,500.
• The vendors received deferred consideration payable over a six year period, but with the tax due upfront (notwithstanding the possibility of CGT by instalments the use of which is more luck than judgement). No-one had discussed the possibility of them using loan notes, and being taxed upon redemption of those loan notes so as to improve cashflow. Because no one had considered that possibility, the vendors also agreed to cease to be directors and employees following the MBO, even though between the two of them they continued to own 20% of the share capital – as a result, they will not qualify for entrepreneurs’ relief on any future sale of the business.
• No mention had been made of the risk of s.455 tax on the upstream loan from the target to the newco – with our involvement coming shortly before the relevant deadline a dividend was voted to ensure that this tax did not become due.
• No thought was given to s.431 elections and none were made. This may result in issues on a future sale.
• One of the management team ‘gave’ his shares to members of his family for reasons which were not immediately clear. However those family members hold less than 5% of the ordinary shares and are not directors or employees and so fail to qualify for entrepreneurs’ relief.
• One of the corporate finance advisers took their fee in the form of new shares in the MBO vehicle. These shares are now held by a company. This company will not qualify for substantial shareholdings exemption (SSE) upon the future sale of the company and instead will be taxable on the company, and then again when the shareholders extract the proceeds. The adviser was unaware of this and could have considered holding the shares personally to avoid two layers of taxation.
• Despite it being customary to do so, no advance clearance was sent to HMRC in respect of the share for share exchange element or the transaction in securities rules.
Whilst this was a reasonably small deal where the business being sold had a value in the region of £1m, the various advisers involved are now spending large amounts of time working back through their files and paying other firms of tax advisers in an attempt to resolve the issues identified above. Of course, I could be accused of sour grapes in all of this, and I understand that, but the bottom line is that all of the participants in the transaction have come out of it with issues that, had they taken tax advice on, would have unlikely to have occurred – or would have occurred with them full in the knowledge of the associated issues.
I know that at times we all want to avoid further costs, in life and in business, but there are so many things that can go wrong, generally speaking an MBO is not the time to close your eyes and hope everything will be OK.