When it comes to planning your departure from the business you’ve nurtured and grown, the concept of an ‘exit strategy’ might seem straightforward. However, the reality is far more nuanced, with a spectrum of possibilities to choose from; among these, the strategy of an internal staff buyout stands out as a remarkable yet underutilized option.
In this article, we dive deep into the world of Internal Staff Buyouts, unravelling how this path not only ensures a seamless transition but also preserves the legacy and values of your business.
We’ll explore why this method is gaining traction as a preferred choice for many entrepreneurs and dissect the misconceptions that might deter you from considering it.
First, let’s look at all the options to a exit strategy
There are so many variations that people might not even consider which includes; but is not limited to:
- Sale internally to staff (Internal staff buyout – this article)
- Pass it on to family members
- Sale externally to investors
- Sale externally to a competitor
- Just walk away and retire
- Partial retirement
Some of those options above are often not thought of, or are written off before even being truly considered.
Let us just explore the first option in this blog in a little more depth; will cover the others in separate blogs, and put to bed some of the “myths” around some that mean they are never thought of.
Internal Staff Buyout – The Preferred Route
For many business owners, an internal staff buyout would be the preferred route for the following 3 key reasons:
- It protects the value of the business a little further by minimising business disruption for customers.
- Can sometimes require a little less due diligence than other methods as those taking the business forward know a considerable amount about the business already
- There is a relationship and level of trust that is already established
The two main reasons why the iternal staff buyout option is often to explored further is:
Let us look at these two “barriers” in a little more detail and provide some extra food for thought.
The idea an internal staff buyout this alone can often prove quite complex as which staff member would put in what amount of money? How much could they afford? Would they even be willing to? What happens if an agreement cannot be reached?
We’re not saying all of these questions do not need to be answered but two common options that hugely assist with this are:
- EMI Share Option Scheme with a potential combined purchase of own shares
- Employee Ownership Trust
Let’s delve deep into these two areas;
EMI Share Option Scheme
With an EMI Share Option Scheme this involves implementing a tax-advantageous share option scheme in the company to enable the members of the management team to obtain shares in the business at a relatively low value and without them suffering a charge to income tax.
That charge could potentially arise because they obtain shares in the company at a value lower than a third party would need to pay for these, the discount arising as a result of their employment with the company.
This scheme can then be combined with the company buying back your shares.
So long as certain criteria are satisfied, the company can buy back your shares with you being charged to Capital Gains Tax on the profit arising.
Potentially, a tax relief called Business Asset Disposal Relief (BADR) should apply thus reducing your rate of tax on the sale down to 10 per cent. Once all of your shares have been bought back, that would then leave the management team as sole shareholders. They should have received their shares without having to pay full value for them and without a tax charge.
You should have been able to extract the value you hoped for out of the company at the lowest possible tax rate currently available, other than through an Employee Ownership Trust (see below). If there is cash already sat in the business this too can further help with respect to the extraction of funds.
Employee Ownership Trust
Finance Act 2014 introduced a new Capital Gains Tax exemption on the disposal of shares by a controlling party to an Employee Ownership Trust (EOT).
The EOT may then hold shares in trust on behalf of employees. The idea behind the EOT is that it holds shares for employees. The employees never hold their shares directly.
Having a trust structure in place avoids the need for special provisions in the company’s Articles or Shareholder Agreements or reconsideration of share valuation when employees come and go because the employee never actually owns shares. The trust is governed by a trust deed.
The company will still need to consider its Articles and create a shareholder agreement. For this to work you would need to sell at least 51% of your shares. There is nothing to prevent a phased sale of the remaining holdings over time, in order to give employees full management (75%+) of the company.
The only disadvantage of the phased sale of the remaining holding is that the later sale is unlikely to qualify for CGT exemption, although Business Asset Disposal Relief (BADR) will be available as long as you satisfy the conditions for that relief and the £1 million lifetime limit for the relief has not yet been reached.
Providing the conditions are met, a sale of shares by you which gives the Trust control will be exempt from CGT. This only applies to disposals where the EOT trustees gain control of the company.
If for example, you sell 51% to the trust in one tax year, and the remaining 49% several years later, only the first disposal is CGT free. This saves CGT of 10% (assuming that BADR would otherwise apply to the gain). There is no cap to the CGT relief available, unlike with BADR which has a lifetime limit of £1 million per taxpayer.
The EOT will need to be funded by a capital contribution from the company, unless it is an existing EBT, in order to purchase its controlling interest from outgoing shareholders. This is not tax-deductible for the company. The EOT can pay for the purchase in stages, with additional capital contributions being funded by the profits from the company over a number of years. The trustees may be able to borrow externally and these loans can be repaid by a capital contribution from the company.
In summary, both of these routes would enable you to achieve your wishes in a tax-efficient manner. The choice between them will essentially depend upon:
- Whether you would wish the management team to own shares and control the business directly.
- Whether exemption from Capital Gains Tax on your share sale proceeds is important to you.
This is a fear that MUST be overcome regardless of which option for exit is explored as if there are concerns about those remaining in your business taking it forward after you exit, then already the value somebody will pay will be less.
This has to be a key component from as soon as you employ staff with respect to employing people better than yourself that can ultimately run your business in your absence for a sustainable period of time.
In summary, we have explored the nuances of internal staff buyouts as a viable and often preferred exit strategy for business owners. This approach, which may initially seem daunting due to perceived complexities, offers a unique opportunity to preserve the business’s legacy while ensuring minimal disruption for customers and leveraging existing relationships and knowledge within the team.
We’ve discussed key challenges such as affordability and ability, and presented practical solutions like the EMI Share Option Scheme and Employee Ownership Trust. These methods not only ease the financial aspects of the buyout but also offer tax advantages, making the process more accessible and appealing.
Ready to Navigate Your Exit Strategy with Expertise?
Exploring an internal staff buyout or any other exit strategy requires careful planning and professional guidance. At Tennick Accountants, we specialize in turning complex scenarios into smooth transitions. Our team is dedicated to providing bespoke accounting solutions and strategic advice to help you achieve the best possible outcome for your business’s future.
Don’t leave your exit strategy to chance. Contact Tennick Accountants today to discuss how we can support you in securing a successful and rewarding business transition.