There is no question that the COVID pandemic and the multiple lockdowns encountered this year have impacted businesses and communities globally. Some sectors have thrived while in others, we have already seen corporate casualties emerge.
As a result, the priorities of business owners have changed with many looking at a range of options to realise value from their businesses. Every individual’s objectives will be different; some may feel they have accomplished the goals they set out with and are now ready to take on a new challenge while others may seek a change of lifestyle or wish to reduce future risk. One thing that is certain is that the impending tax reforms to Capital Gains Tax and Business Asset Disposal Relief are bringing this consideration to the fore for many shareholders.
Options for Exit
Whatever the motivations might be, it is worth exploring the various alternatives to exit your business. In our series “Exploring Exits”, we gave an overview of the most common options for exit:
- Trade sales – this could be by way of a share or asset disposal to another business, typically operating in the same sector, or to a private equity investor (for which a strong management team will need to be retained in your business post exit). A trade sale may be to one already identified purchaser or may be sold through an auction process, i.e. where multiple potential purchasers place bids for the business based on preliminary first round due diligence.
- Sale to a management team (MBO) – the sale of a target business or company to the existing management via a transaction known as a management buyout. The management team will typically gather together resources and funding to acquire a business, and this may come from a range of different sources, for example, personal finance, private equity backing as well as seller-financing.
- Sale to an Employee Ownership Trust (EOT) – employee ownership trust structures may be used when a selling shareholder wishes to dispose of at least 51% of its interest in a company to a trust which is set up for the purpose of holding shares for the benefit of all the employees of the business. The EOT is likely to pay for the acquisition over time applying profits made in the business post exit. The EOT may be a new company specifically established to act as trustee with directors appointed from the workforce and/or external independent appointments or it could be an independent professional trustee entity.
- Merger with a competitor or complimentary business – a merger is an agreement to unite two existing companies into one company. True mergers tend to be less common than straight acquisitions of a company’s shares or assets and are more likely to occur in the third sector.
- Members voluntary liquidation – it may not always be possible to sell your company to a third party or the management team. A member’s voluntary liquidation (MVL) is a tax-efficient way of dealing with this for the shareholders, where the company has net assets, such as real estate or cash that can be realised independently. The company must be financially solvent to be wound down by way of an MVL. To qualify, the company must be able to pay its creditors within 12 months and at least 75 per cent of the shareholders entitled to vote at a meeting of the creditors must vote in favour of it.
M & A activity
During the course of 2020, we saw a drop off in M & A activity while many directors chose to “wait and see” and focus on restoration, recovery and just staying afloat. We also saw private equity houses “keeping their powder dry”, consolidating their existing portfolios with additional investment and resource.
In the last quarter of 2020, we are witnessing increased M & A activity, with many business owners now looking at their options. Private equity houses are becoming more active again supporting strong management teams either in new sectors (medtech and digital and the “knowledge” sectors) or those sectors that have shown resilience to the impact of COVID. As expected, there is now substantial liquidity in private equity which will be pivotal to our economic recovery.
There are many benefits to selling to, or accepting an investment into your business from, a private equity house, including the ability to obtain finance from multiple sources (i.e. equity and debt), the opportunity for the business owner to realise some equity value by taking some funds out (thereby re-risking), and the ability to incentivise a new tier of management and so create options for growth coupled with succession and final exit. We have seen an increased uptake of private equity investment from owner managed businesses. This will be considered further in the next article in this series.
Impact of COVID on company valuations
The timing and methodologies used for business valuations will be crucial to sellers. In periods of excessive volatility valuations are more difficult and challenging, valuations will be wider and could change quickly. Valuation information will need to be analysed more carefully to take account of temporary surges and blips caused by the COVID pandemic. Certain sectors will have been attributed higher or lower multiples to reflect increasing or decreasing levels of profitability – but how sustainable are these?
Impending tax reforms
We have already given our views on the OTS Review of Capital Gains Tax. The impact of these potential tax changes will be significant for those considering a sale of their business as the income tax net is effectively cast much wider than it is currently, to capture what has until now benefited from CGT treatment.
By way of an example, if shares are sold for £10 million, under the previous regime, capital gains tax of £2 million would have been payable, whereas under the new proposals it would be much higher, an eye watering £4.5million. The knock-on effect is that retiring business owners will need a careful reassessment of their financial and retirement plans. Many may choose to delay an exit until sufficient value has been generated in their businesses again or indeed taken out as the incentive to grow the business is greatly diminished.
For those seriously considering exit options, transferring their business to an EOT may become an increasingly attractive alternative and we expect to see a rise in these types of corporate transactions. We have already seen an increase in EOT structures during 2020, but it is important to highlight that these structures shouldn’t be embarked upon for tax reasons alone. If done for the wrong reasons sellers could end up with unintended results and a structure that is not designed to be unwound. That is why it is imperative to be clear about your objectives and what your options are at the outset.
What should you do now?
As with any corporate transaction, preparation is key. You may be considering an exit from your business or you may already be involved in the process. There is a window of opportunity to benefit from current tax rates, but careful thought and consideration must be given to the key aspects of any exit alternatives, such as deal structure and timetable, valuation, identification of a buyer or investor and most importantly what your key drivers and long term needs are.
We would be delighted to assist you and speak with you about your options. If you wish to discuss anything raised in this article further, please contact Jennifer Gallagher.
