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Succession of family businesses: management buyouts and share buybacks


We’ve teamed up with Family Business United in our search to find the oldest family-owned businesses across Essex.

Alongside this inaugural piece of research, we’re issuing a series of articles examining the factors that go into succession decisions and the different types of succession strategies that we tend to see used.

The first of our articles in this series looks at management buyouts (MBOs) and share buybacks. MBOs and share buybacks are typically used to engineer a tax-efficient exit for more commercial business owners. However, they can equally apply to family business succession scenarios.

Typically this will be suitable where the older generation wish to extract some capital to fund retirement or help equalise inheritances between children involved and not involved in the business. Alternatively there may simply be a view of not wanting to push too much wealth down too early.

A key tax issue with these scenarios is obtaining HMRC tax clearance that the transaction can qualify for Capital Gains Tax (CGT) treatment. If granted, it can suffer either

  • 10% CGT with the benefit of Business Asset Disposal Relief (BADR, formerly Entrepreneurs’ Relief) up to a maximum lifetime limit of £1 million of BADR gains; or
  • 20% otherwise or thereafter, rather than c. 40% if it’s taxed as income.

Given the funds for the sale proceeds will generally be coming from within the company, this is a real risk. HMRC will need to see the relevant criteria being satisfied and the commercial rationale for the transaction before approving it.

There are some specific nuances between the two approaches which we briefly comment on below, in the context of family businesses.

Share buybacks and family owned businesses

Although an older family member may wish to extract some capital tax efficiently from the business, they won’t generally want to put the company’s cash flow under undue pressure.

One of the challenges with share buybacks, which involve a company repurchasing (and cancelling) some but not all of its shares, is that the Companies Act does not permit deferred payments for the shares. Furthermore, the company needs to have the distributable reserves to support the payments from an accounting viewpoint.

A potential way around this is the more complex ‘multi completion buyback’ approach, albeit HMRC has recently clarified its interpretation of the ‘connection’ condition, which can interfere with capital treatment in these scenarios.

Broadly, after the first tranche of shares are bought back (coinciding with the agreement to sell the shares), the vendor and their associates cannot collectively still possess more than 30% of the shares (which will include those that they have agreed to sell but not yet completed on).

In that context, fortunately, adult children are not treated as associates, but this rule does create some extra complexity in the context of those types of buyback transactions.

The other big challenge with share buybacks is satisfying HMRC that the subjective ‘trade benefit test’ is met. In a family business scenario this can be particularly challenging and they will generally be looking for a firm commitment regarding the older generation’s step away from the business, i.e. how and when they will be reducing their physical involvement and when they intend to retire as statutory directors of the company.

MBOs for family firms

MBOs will normally involve the creation of an additional company and the sale of 100% of the existing company to that new company, with the remaining shareholders getting shares in exchange for their old shares, and the vendor shareholders receiving a mixture of cash, IOUs, loan notes and rolled over equity.

As well as creating an extra company, MBOs will typically involve more stamp duty (at 0.5%) than share buybacks.

MBOs offer the potential to rollover part of the capital gain for the vendors, via the use of formal loan notes, until such time as the relevant funds are actually received.

MBOs also have different conditions for capital treatment. Instead of a specific list of criteria that must be met, the tax treatment (broadly, CGT or income tax) hinges on whether HMRC consider the Transactions In Securities (TIS) anti-avoidance rules to apply.

Generally where there is a change of control taking place as a result of the transaction, then more often than not, HMRC will grant this clearance. However, this is not guaranteed and they are likely to take a closer view of the transaction in family business succession scenarios.

There is a ‘safe harbour’ route to avoiding the TIS rules which requires at least 75% of the company to be owned, after the transaction, by individuals previously not shareholders nor connected with any of the former shareholders. This will generally be of no use in a family business scenario, and therefore the tax clearance will be crucial.

We could go into much more detail about the comparison between these types of transactions, however that is outside the scope of this brief article. Suffice to say, each case should be judged on its merits as to which approach is more appropriate.

To discuss your particular circumstances in more detail and evaluate the most suitable option for you, please contact James Boustead via our online enquiry form .

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