Sow wisely for business success - Part 3: Planning the perfect exit

Lesley Stalker, Simon Patterson and Paul Webb, partners at the Robert James PartnershipIn the third of the three part series on how to successfully grow your business, Lesley Stalker, Paul Webb and Simon Paterson, partners at the Robert James Partnership, give practical advice on how to plan for exit.

For many entrepreneurs, an eventual sale is the single biggest reason for starting a company in the first place. Many business owners see a lifetime's hard work ruined due to poor planning, a lack of awareness of the value of the business and a failure to master the basics of selling a company In fact, you could end up paying up to 40% more tax than the allocated 10% rate for capital sales. Here's our practical guide to ensuring you know what to do when the time is right to sell up and release the equity in your business.

Plan ahead

Ideally exits should be planned as soon as possible, or in cases where the intention is to sell the business after a certain period of time (e.g. two years after its creation), the exit should be factored in to the start-up business plan.

Exit options

There are a number of ways of exiting or disposing of a business. Business owners should consider the best option for them in line with their personal objectives. Different options which require strategic tax planning include: 1) trade sale, 2) management buy out, 3) family succession, 4) management buy in, 5) stock market flotation and 6) merger with another business.

Exit through trade sale

A trade sale occurs when you sell the business (or parts of it) to another outside party. This is deemed as the best possible way to get maximum value from your business and is one of the most common exit routes.

In order to make a successful transaction, you should identify possible buyers and work to develop your business for a sale that they will accept. If business is going well, you will already be on a potential buyer's radar, and therefore it's quite likely that would-be buyers will be approaching you directly. Selling your business will be easier if you can:

To help market your business it is worth creating a "seller's pack" containing this information. Your accountant can help you to collate and present yourself in the best possible way to attract the right buyer at the best price.

Know your reason for selling

Part of preparing your business for sale is getting ready to deal with buyers and their questions. One obvious but often neglected question you are likely to be asked by prospective buyers is: "why are you selling?"

For some industries, for instance IT, the objectives for setting up a business (and ultimately selling it) might include; generating capital growth and making money by selling the business, or creating an invention or piece of intellectual property, developing it and selling it on quickly. By detailing out the business objectives at start up, when it's time for the business to be sold the reasons for doing so will be apparent.

For other businesses, the reasons may not be so succinct. It may be that original objectives such as wanting to pass something on to future generations are no longer the case. Whatever your reasoning, think carefully and prepare your answers – potential buyers will quickly spot if you are selling out of desperation!

Understand what you are selling

According to the latest research, only half of entrepreneurs planning to sell their business know how much it is worth.

The value of your business will be determined by a number of factors: its size, future growth prospects, diversification, customer base, profitability and cash flow as well as financial management.

Whilst you do not want to undervalue your business you should not overvalue it either.

Selling shares or assets?

The first question to ask during initial negotiations is whether the business is to be sold through the sale of shares or as an asset. This decision will undoubtedly be driven by tax considerations.

In a share purchase the purchaser buys the target company along with all its assets and liabilities. An asset purchase allows the purchaser to try and "cherry pick" the particular assets he wants to acquire, without necessarily acquiring all of the liabilities, (except for employees). There are also other key differences between the two types of transaction, including the form of documentation required for the transfer, tax and stamp duty implications, and in relation to the distribution of the purchase price.

In most cases, sellers - primarily for tax purposes - prefer to sell shares; whereas vendors prefer to buy the assets. In practice, most transfers of business are done by way of a share purchase, as otherwise the sellers, in effect, pay capital gains tax twice. This is because the company pays corporation tax on the sale of the assets upon which the capital gain is made, and the sellers pay tax when the cash is taken out of the company, either by way of a dividend or bonus or by liquidation of the company.

Getting the fundamentals right

Ensure that the business' financial and legal information is up-to-date. Once you have found a suitable buyer, their solicitors and accountants will normally wish to carry out a financial review of the business known as a 'due diligence'. This audit will involve them gathering information about all aspects of the business so that the buyer can make an informed decision and modify the terms of sale if necessary. It is therefore important that you gather together the financial information required. This may include:

It is therefore important to ensure that all these details, budgets and business plans are ready to be inspected by potential buyers.

Heads of terms

'Heads of terms' precede the main contract and highlight the principal issues of the agreement and the intentions of both parties. The 'heads of terms' may contain:

It is essential that professional advisers such as solicitors, accountants and specialist tax advisers are appointed early in the sale process and before these 'heads of terms' are agreed. In a court of law this document may be considered as legally binding. In our experience as tax advisors, many clients come to us already having signed this document, simply because they didn't appreciate the future tax implications of the sale. And whilst it isn't impossible to re-negotiate terms, you the vendor are in a far weaker position with the purchaser.

Tax implications

Before selling your company you may want to consider tax efficient strategies of withdrawing funds from the business. Ways in which to do this include paying dividends, bonuses and termination payments. However, if you do make these sorts of withdrawals it may affect the sale price of the company. Similarly, you need to strike a balance with the amount of cash you leave in the business, as HM Revenue and Customs (HMRC) can view excessive amounts as tax avoidance and penalise accordingly.

Capital Gains Tax and selling shares

Any profits you make from the sale of your shares will be liable to Capital Gains Tax (CGT). CGT is worked out for each tax year (which runs from 6 April one year to 5 April the following year). It is charged on the total of your taxable gains, after:

How much CGT you pay depends on your overall income. Your total taxable gains are added to your taxable income for the year and treated as the top slice of that total. The gains are then charged to CGT at the following rates (2007-2008 tax year):

Taper relief

Taper relief, introduced in April 1998 reduces the amount of the net chargeable gain the longer the asset is held. Taper relief is based on the size of the gain and the length of time an asset has been held.

Business assets are entitled to taper relief over the relevant period, with maximum relief accruing over 2 years. Only complete years qualify at the following rates (with no bonus rate):

Exemption Effective Tax Rate
Year 1 50% 20%
Year 2 75% 10%

How this can work in practice

Supposing you start up a high tech business from scratch that is in a high growth area and is very attractive to speculative investors. If you sold the business for £10 million after one year from the date you started trading you would effectively have to pay 20 % CGT tax on the whole sale, unless you include an element of "deferred consideration" into the sales contract. In this way you could pay 20% on a portion of the sale, and then, by waiting until another year to claim the rest of the purchase capital, could be eligible for the 10% rate on the proceeds for the remainder of the business. Accruing these benefits is something a tax advisor would structure into the sale terms on your behalf.

VAT

If your company is registered for VAT, you will need to contact HMRC and complete form VAT 7 to cancel your registration, or form 68 to transfer your registration to the new owner.

Exit planning can be confusing for business owners, especially if this is the first time they have sold a business. Before committing to any decisions it is essential that you seek advice from a suitably qualified expert early on in the process. For many, being in the position of selling marks the culmination of many years’ hard work and personal sacrifice. A well-thought out exit strategy will enable you to maximise your end rewards in terms of the value you ultimately get from your business. An ill-thought strategy may leave you wishing you hadn’t sold up at all!

What next?

After you have sold up and pocketed your windfall, many entrepreneurs are left wondering what next. Indeed many really love the excitement of creating a start up and do go on to form new ventures. Another potentially lucrative and very personally rewarding option is to sell your knowledge to others. Having been through the experience of creating and selling a business, many entrepreneurs pass on their lessons learned to others, as non-executive directors or business development advisors.

For more information on tax planning visit www.rjp.co.uk.

Previous articles in the series

Part One: Setting up a new company
Part Two: Growing beyond the start-up phase

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BusinessZONE - 5-Jul-2007
Categories: Tax, Money matters
Story read: 3095
Number of comments: 1

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Increasing the Value of your business

Brian Holt, 6-Jul-2007 

This is an excellent article on the tax implications of a business sale. It’s my experience as a business broker, that many owners fail to focus on are the bullet points:
Show year-on-year increasing profitability and growth prospects
Create a high-quality product or service
Develop an innovative product or piece of intellectual property
Build a strong customer base
Recruit a high-quality team
Maintain premises and assets in good condition

These and many other factors influence the value of any business. Owners fail to recognise that preparing a business for sale can take up to three years if they are to achieve the optimum value.
Many enjoy a good lifestyle and develop a belief that their business is worth far more than the value placed on it by hard-nosed buyers.

The authors are absolutely right in advising owners to take early advice with regard to tax matters. They would be equally well advised to seek early advice from a competent broker with regard to the true market value of their business, the timing of the sale, and the actions needed to achieve the optimum deal at exit.