Unlocking the value in your business
A partial exit can be an ideal way to release some of the equity you have built up in your business. It can also inject additional funds to really drive your business forward. But make sure you think through all the implications before you act.
Why seek a partial exit?
Traditionally, if you wanted to release the capital value locked up in your successful business you had two basic options: you could sell it or go for a stock market flotation. But what if you feel you still have much to contribute to the development and growth of your business? What if you don’t want to expose yourself and your company to the public gaze of being a quoted company? What if you don’t want to sell your controlling stake?
You might then consider a partial exit, by selling some of your capital to a new private investor.
You might also be attracted to a partial exit if you want to protect your personal financial position. After many years of hard work, you may want to avoid all of your wealth being tied up in one investment (your business).
What stake to sell?
Deciding the amount of shares to sell can be a delicate balancing act. You want to realise some worthwhile value, but don’t want to create the perception that you are no longer committed to the future success of the business.
Retaining a controlling stake or reserved power at least is particularly important if things don’t go to plan post sale. Given your knowledge of your business, you will still probably be the person best placed to take key decisions at critical moments. To ensure you have the necessary power to do so, you need to retain control or retain reserved powers, which often means retaining a majority stake.
In general, a partial exit is most likely to succeed if you retain a good level of control of your business. If you really want to relinquish control and responsibility as well, then a 100% sale could well be the better route for you.
Maximise your business appeal
When seeking a partial exit, you need to think about what will attract potential investors. Firstly, they will want to back a well established, successful business that is growing. If that’s not the case, they are unlikely to be comfortable swapping their equity for yours!
It’s also important to note that transactions involving partial exits are typically structured with as much debt as possible. So having a business with strong cash flows to facilitate the debt is a must.
As noted, you will need to demonstrate that you are still committed to the business going forward. If you are seeking a more passive role, you will need to show that your management team is good enough to run and develop the business successfully without your daily input.
Whether you are actively involved or not, the ongoing management team must be able to demonstrate that the business is capable of growing – at least at the same rate as it has achieved historically. Ideally, the investor will be seeking even faster growth, following the extra cash injection.
The exact terms of the deal will determine the tax treatment of a partial exit, so the structuring of the deal will be crucial to achieve the best tax outcome.
If your investment is held personally, capital gains tax (CGT) would normally be due on the gain arising on the sale of shares. From 6 April 2016 the rates of CGT, with the exception of sales of residential property, are 20% for higher/additional rate taxpayers and 10% for basic rate taxpayers. However, assuming that you are also an officer of the company and hold at least 5% of the share capital, Entrepreneurs’ Relief may also be available. This would result in CGT being payable being reduced to 10% for higher rate taxpayers.
If the shares are in a trading company and are not held personally but are instead being sold by a holding company owned by you, an immediate charge to tax could normally be fully avoided on the gains arising on the sale, as long as conditions can be met to enable a claim to be made for substantial shareholdings exemption (SSE), which would result in a complete tax exemption of the gain/loss on sale.
Finally, if the terms of the deal involve non-cash consideration, such as the issue of shares or debt in the new investor’s company, any chargeable gain on that portion of the proceeds may be deferred until the later sale of the newly acquired shares or redemption of the newly acquired debt, provided important conditions are satisfied.
Choose your investors with care
Carry out as much due diligence on your potential investor and their team as they conduct on you and your business. Think carefully about whether you can work well together. Gain an understanding of their approach and the team they have allocated to your business. They will usually seek to be actively involved and will want to contribute to the success of their investment. This means you will see a lot of them – particularly if things don’t go according to plan. Try to talk to other companies where your investor has a stake to get some direct insights into their management style to ensure it accords with your own expectations.
Your investor may often want to provide for their later exit from the business as well; typically by completing a sale within a three to five year timeframe. You need to assess whether their preferred timeframe is in keeping with your own plans, because it’s probable that you will need to exit at the same time.
If you’d like to find out more about how to achieve a partial exit, please get in touch.